The end of QE: why is the euro not benefitting?

What to Worry About Today: The euro

We always complain about the misuse of language by financial types, such as “dovish hike” or “hawkish hold.” It’s an effort to combine a policy action with a forecast by a central bank, and often reveals that central banks are juggling more balls than they can handle and are going to drop one of them. 

The euro waffled around before, during and after the Draghi press conference, and it was not until China reported worse than expected data that it actually broke out to the downside. The two big negatives in the ECB experience were the GDP forecast lower by a tiny amount, 0.1%, for both this year and next. One-tenth of one percent is a tiny number, literally within the margin of error. It’s not good, but it’s also not catastrophic.

What really did the trick was Draghi saying the “balance of risks is moving to the downside” for the eurozone economy. Draghi named global uncertainties (Brexit) and protectionism (Trump) as the first two issues causing risks to a rise in risk. He also named emerging market problems and high volatility, but we can easily trace these back to the first two. If these problems were not so obvious and dire, at any other time a central banker would not feel safe blaming others. But this time not a single voice is raised. 

The WSJ report “A recent ECB paper concluded that bond purchases weakened the euro-dollar exchange rate by 12%. And the effect kicked in even before the bank launched bond buys. The euro weakened as early as April 2014, when Mr. Draghi signaled in a speech that QE was a possibility.” The accompanying chart is supposed to illustrate that QE was solidly bad for the euro, when we had more than one instance of a decent recovery since QE was announced.

This brings up an interesting point—if what we have is the end of QE, which will culminate some day in interest rates rising—why is the euro not benefitting? The Event yesterday ending QE, “should” have been seen as a key tipping point and a historic event. It was announced well in advance and even with Draghi suggesting rate changes are even more distant than the original plan, such as it was, we should have seen a “buy on the news” effect, Chinese data notwithstanding. We wonder if the euro will not benefit, if belatedly, on the story.

Analysts say it is the downward revision to growth and inflation, plus pushing out any rate changes even further, that is weighing on the euro. We don’t buy the conventional view in its entirety. After all, the Fed is likely to be doing exactly the same thing next week.

We will have a good indicator of that doubt if and when Trump does indeed raise the Chinese tariff from 10% to 25%, within the 90 days (jumping the gun) or making loud noises about it. If the euro falls and there are no other reasons as the time, we will see the euro influenced more by external events (threat to German exports) than by internal ones in the form of the central bank bias. 

 

Outlook:

If there is one thing traders dislike as much as high uncertainty, it’s central bank nuance. That’s why we have ridiculous terms like “hawkish hold.” The market would have been perfectly content to live with a tiny 0.1% drop in the eurozone GDP forecast and even a realistic forecast of slowing growth next year (from 1.9% to 1.7%), but then Draghi had to spoil the party by naming unmanageable causes—global uncertainties and protectionism. The first is chiefly the UK’s fault with a dollop of Italy and Trump, and the second is due entirely to Trump. He might just as well as said “incompetent management” in two top countries.

We expect the euro to recover at least a little after these shocks wear off and as everyone recognizes that the Fed will be reining in rate hike expectations, too.

In the US, we get a lot of fresh data today, of which the most important is probably retail sales. If consumer confidence is high, sales should be good, despite clouds forming on the horizon. We also get manufacturing output, but the market often disregards that one. It’s a little interesting that some forecasts have retail sales disappointing while manufacturing goes up, and others have it the other way around. Uncertainty about data is fairly rare.

The dollar will likely consolidate gains today. We are already looking forward to the next pullback Tuesday.

Political Tidbit: The news developments in the case of the US v. Trump are not as seminal and decisive as the anti-Trump newscasters might like us to believe, but they are not chicken-feed, either. This time we have investigations into the Trump campaign use of money, especially at least one case of illegal “pay for play.” We already knew about this for a long time so the delay in the Justice Dept is annoying, but now they are on it, as well as the strange case of tens of millions going missing from the inaugural fund or going to questionable cronies. We also have the Russian agent admitting to infiltrating the NRA to influence the election; the NRA spent $30 million on the Trump campaign (vs. $10 million for the previous GOP candidate Romney).

At some point, it will be recognized that Trump is too disorganized and incompetent to have master-minded any kind of collusion. He can be right about that. But a large number of the people around him, inner and outer circle, were sleazy crooks and the buck stops at the top. We wonder if Trump will not be painted to a resignation corner by (say) September. The cheer will be heard around the world… You can just hear him now: “I don’t need this S***.”

Until we figure out that means the hapless, robotic and religion-addled VP Dence.

 

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