ECB QE in focus

The Day So Far

US equities surged higher again yesterday printing yet another all-time high. The positive reaction to the Italian situation, expectation of more QE from the ECB, and the ‘Trump factor’, all seem supporting factors when trying to explain the strength of the climb higher. In fact in total since the US election global financial markets have seen a $2trl rotation out of debt and into the stock market with the risk on sentiment resulting in the JPY falling the most in 21-years against the mighty USD. Although there is no denying this firm trend across assets I still have lingering fears that the market may have been overly aggressive in pricing in this Trump inspired stimulus. In essence, I still believe there is a moderate implementation risk associated with the administrations aggressive plans, and in combination with the political threats in Europe, a degree of caution is still warranted in the medium to long-term. But as the old saying goes you have to live in the moment and for this week I see no reason to question the equity rally that was kick started on Monday after the Italian referendum.

The Afternoon View

Looking ahead the best is yet to come with the ECB meeting being of particular interest given the broad expectation that the Bank will look to extend QE beyond the March 2017 deadline. The question here is not so much will they extend but more the size of the monthly purchases and the duration of the programme. The consensus here is for a 6-month extension at the same rate of ‎€80bln per month, however, a smaller minority are of the belief that the ECB could opt to drop the rate down to €60bln but extend by 9-months until the end of the year. The latter would actually result in the ECB buying more bonds and covering themselves over the German Federal elections in September, but if this materialised the initial interpretation could well be hawkish to a headline drop of €20bln, so volatility on the 12.45pm announcement can be assured with the market placing higher importance on the tapering signal rather than the extension itself. As per usual the greater move will likely be over the press conference where Draghi has the difficulty task of communicating the associated parameter change to the conditions in which the purchases are made under the QE program. The options here are three-fold but at least we can list them in the likelihood of them happening. The first would be a removal of the yield floor, then relaxation of the issuer share limit, and finally the least likely would be a shift from the capital key. Overall this will be a tricky event to trade as there are several variables to weigh up in order to asses the full ramification of the changes that have been made. The market is heavily net-short in total open interest and with the fear of the ‘T-word’ being mentioned anything short of dovish may cause another short squeeze similar to that on Monday.