The Week Ahead: The ECB Takes a Step Closer to QE

Highlights

• Market Movers: Weekly Technical Outlook
  
• The ECB Takes a Step Closer to QE
  
•  Look Ahead: Equities
  
•  Look Ahead: Commodities
  
• Global Data Highlights

Market Movers: Weekly Technical Outlook

Technical Developments to Watch:

• EUR/USD turning lower off bearish trend line resistance, more weakness favored
  
• GBP/USD resistance looms up at 1.5825, downtrend intact
  
• USD/JPY hesitating around 118.00 resistance – will we finally see a pullback?
  
• USD/CAD in play, 3-month bullish trend in jeopardy

* Bias determined by the relationship between price and various EMAs. The following hierarchy determines bias (numbers represent how many EMAs the price closed the week above): 0 – Strongly Bearish, 1 – Slightly Bearish, 2 – Neutral, 3 – Slightly Bullish, 4 – Strongly Bullish.
** All data and comments in this report as of Friday’s European session close ** 

• EUR/USD inched higher to bearish trend line resistance last week before turning lower on Friday
  
• MACD and Slow Stochastics turning higher
  
• Bias remains bearish below bearish trend line resistance near 1.2550

EURUSD had a rather uneventful week, with rates inching gradually high in slow trade to test bearish trend line resistance in the mid-1.2500s before turning lower on Friday. The secondary indicators predictably moderated from the previous week’s extremes, with both the MACD and Slow Stochastics turning slightly higher. This week’s economic calendar brings only second-tier economic reports out of Germany (see our Data Highlights section below for more), so the longer-term technical downtrend could reassert itself this week, and EURUSD’s bias will remain to the downside as long as bearish trend line resistance holds (see chart).

Source: FOREX.com

GBP/USD

• GBP/USD peeked below 1.5600 last week before bouncing on decent UK retail sales data
  
• MACD still shows bearish momentum, Slow Stochastics turning higher from oversold territory
  
• Medium-term bias remains bearish below trend line resistance

Similar to its mainland rival, GBPUSD saw minimal volatility last week; rates initially dipped back down to previous support at 1.5690 before bouncing back on the back of decent UK retail sales figures on Thursday. As we go to press, the MACD is still below both its signal line and the “0” level, showing bearish momentum, though the Slow Stochastics are turning higher from oversold territory. For this week, a bounce back to the 20-day EMA and bearish trend line around 1.5825 is possible, but as long as those levels hold, the path of least resistance will remain lower for GBPUSD.

Source: FOREX.com

USD/JPY

• USDJPY surged to 119.00 before losing momentum on Thursday
  
• MACD remains strongly bullish, but Slow Stochastics starting to turn lower from overbought territory
  
• Elevated chance of a short-term pullback off previous resistance at 118.00

USDJPY extended parabolic surge all the way to 119.00 last week on the back of a disappointing Japanese GDP report and increasing political turmoil last week. As we’ve repeated emphasized in this report over the last few weeks, parabolic moves like the rally we’ve seen in USDJPY have a tendency to run further and faster than many traders expect, but they are notoriously vulnerable to violent corrections so bullish traders are encouraged to tread carefully this week. After losing its momentum at previous resistance near 118.00 last week (not to mention the Slow Stochastics rolling over from overbought territory), the risk of a near-term pullback is perhaps higher than it’s been in recent weeks. If we do see a pullback, the first level of support to watch will be the 23.6% Fibonacci retracement of the 5-week rally near 116.00.

Source: FOREX.com

USD/CAD

• USD/CAD peeked below the bottom of its 3-month bullish channel on Friday
  
• Both MACD and Slow Stochastics indicate generally balanced, two-way trade
  
• All eyes on the bottom of the 3-month bullish channel

USD/CAD is our currency pair in play due to a number of high-impact economic reports out of the US and Canada this week (see “Data Highlights” below for more). Looking to the chart, the pair dropped briefly through the bottom of its three-month bullish channel in the mid-1.1200s on the back of a strong Canadian inflation report Friday, though rates have recovered slightly off the intraday lows as we go to press. Both the MACD and Slow Stochastics indicator are showing generally balanced, two-way trade, so the pair may take its inspiration from this week’s economic data. A deeper pullback is possible this week if rates conclusively break below support at the bottom of the three-month bullish channel.

Source: FOREX.com

The ECB Takes a Step Closer to QE

On Friday, ECB President Mario Draghi delivered a damning indictment on the Eurozone economy, saying that underlying growth momentum remains weak, the economic situation in the euro-area remains difficult and that the inflation situation has become more challenging. He ended his speech by saying that a prolonged period of low CPI has weighed on some inflation expectations, which he said were “excessively low”. Although he didn’t use the words quantitative easing, he said that the ECB would have to broaden their asset purchases if inflation does not rise.

This is worth noting for a few reasons: firstly, it was the second time this week that he has touted QE as the next policy tool in the ECB’s weaponry; secondly, Draghi was giving this speech at the European Banking Congress, which is held in Frankfurt. Basically, Draghi was giving his support to QE in the de-facto home of the Bundesbank, a noted opponent to a Fed-style QE program for the currency bloc. Either Draghi has gone rogue and is showing his support for radical action like QE to boost growth, or the Bundesbank are coming around to the idea. While the former point is preferable, the latter is most likely, since the Bundesbank is unlikely to change its tune on QE so quickly after recently stating their opposition to it.

We continue to think that political opposition to QE in the coming months is high, even though the Eurozone economy is weakening, as evidenced by drop in November PMI to a 16-month low last week. The ECB is unlikely to announce a QE program at the December meeting, and we don’t think this is a reality at least until Eurozone CPI falls below 0%.

So, what does this mean for the single currency? Before Draghi spoke on Friday the EUR had recovered somewhat and was higher on the week. This was mostly driven by strength in EURJPY, which rose to its highest level since 2008. However, after Draghi’s speech, which seemed to ask the Bundesbank to give QE a chance, the EUR sold off sharply. By Friday’s European session close, EURUSD was hovering close to 1.2400, near the YTD low at 1.2358. We continue to think that the recent recovery in this pair was short-term only as economic headwinds and divergent policy stances at the Fed and the ECB weigh on the single currency. We maintain our view that EURUSD could test 1.20 by the end of Q1 2015.

Look Ahead: Equities

What started as a lackluster week has ended as a broad-based rally for European stocks after a surprise interest rate cut from China and hints that the ECB is getting ready to announce QE boosted sentiment towards riskier assets. The Eurostoxx index is on target to close the week up nearly 5%, while the FTSE 100 is up approximately 2% this year and has broken through its 200-day sma.

The materials and energy sectors were the top performing after China unexpectedly cut interest rates early on Friday. Earlier this week, China’s manufacturing PMI survey for November fell sharply, narrowly missing contraction territory and this seems to have spurred the People’s Bank of China (PBOC) into action. Investors are pricing in the prospect of the rate cut spurring growth and boosting demand for commodities, which has led to the outperformance of the materials and energy sectors of the FTSE 100.

European markets actually outperformed the FTSE 100 on Friday. Spain’s Ibex managed to reverse losses from earlier this week and jumped to its highest level since the beginning of the month; likewise, the Italian FTSE MIB was also up 2.5% at the end of the week. Italian and Spanish indices were boosted by comments from Mario Draghi that focused on the ECB’s need to take further action if inflation continued to remain weak. Signs that the ECB could embark on QE in the coming months could brighten the outlook for downtrodden European economies like Italy, which contributed to this rally in global markets.

So are these gains sustainable and can we expect to see further upside at the start of this week? There seems to have been a dovish shift at the major central banks: the ECB and BOJ are likely to continue to ease policy, China may cut rates again if growth does not pick up, the UK’s plan to tighten policy seems to have stalled, and Scandinavian and Australian and New Zealand central banks are either on hold or willing to loosen policy further. The US is the odd one out, with the market still expecting the Fed to hike rates in the middle of next year. This structural shift to a more dovish stance in global policy is good news for stocks, as loose monetary conditions boosts liquidity, and equity markets love liquidity. Thus, any downside could be limited, especially if the ECB actually pulls the QE trigger in the coming months.

The major indices also look strong from a technical standpoint. The FTSE 100 and Eurostoxx 50 are both above their 200-day moving averages, while the S&P 500 made another record high at the end of last week. Looking at the FTSE 100 in depth, last week’s break above the 200-day MA at 6,695 was a bullish development that opens the way to further gains. The 6,800 level could trigger some profit taking ahead of 6,904 – the high of the year so far. A word of warning about trading on Mondays: the last few weeks we have seen some unusual moves and counter-trend swings take place on a Monday, which have then been reversed the following day. So, if we see stocks take a breather at the start of next week, this may not necessarily herald the end of the uptrend.

Source: FOREX.com. Please note that this a Bloomberg chart and does not represent the prices offered by FOREX.com.

Look Ahead: Commodities

Gold rose more than 2% last week, as dovish comments from the ECB alongside China’s rate cut spurred demand for the yellow metal. China has overtaken India as the world’s biggest consumer of gold, so accommodative action from the PBOC can be supportive for the precious metal. At the end of last week, it managed to reclaim the $1,200 handle and was testing critical resistance at $1,207 – the 50-day MA. A break above this level would be a positive development that could open the way to $1,231 – the 38.2% retracement of the March high – November low. However, we continue to think that this is a short-term adjustment in gold and that the longer term outlook is still tricky for the precious metal. China did not pledge to cut rates further on Friday and a strengthening dollar could keep gold’s price gains in check; added to that, global inflation pressure is weak, which reduces the need for an inflation hedge like the yellow metal. Thus, we could see profit takers come in at the start of a new week, and this recovery rally could start to fade around the 38.2% retracement level at $1,231.

Source: FOREX.com. Please note that this a Bloomberg chart and does not represent the prices offered by FOREX.com.

Global Data Highlights

Monday, November 24, 2014

9:00 GMT German IFO Business Climate, Current Assessment, and Expectations (November)

• In a surprising twist in the tale of the flaming inferno that has been the European Union’s economy of late, the German ZEW survey this past week surged to its highest level since July and reversed a declining trend that was consistent since the start of 2014. Does that mean that Germans are now feeling a little more confident about their future? We’d be hesitant to say that as European Central Bank President Mario Draghi insinuated this past week that future inflation expectations are falling, and the Eurozone may very well need to institute Quantitative Easing. Therefore, it may not matter how German sentiment feels about the situation, the EUR may be a one-way street lower regardless.

23:50 GMT Bank of Japan Monetary Policy Meeting Minutes and Governor Haruhiko Kuroda Speech

• The shock of the increased QE from the Bank of Japan a couple weeks back still hasn’t worn off the market as JPY crosses continue their perilous climb ever higher. The BoJ shock value wasn’t the only thing spurring the continued rally though, as Prime Minister Shinzo Abe called for snap elections, announced a delay in the next sales tax hike, and the GDP declined 1.6% on expectations of a 2.1% increase. All of this activity has led many observers to question the validity of Abenomics as it has failed to spur inflation or growth in any substantial way. The BoJ’s meeting minutes may help to shed new light on any plans of additional easing from the institution, and whether they had discussions to add even more liquidity than they did on that fateful Halloween night. If you don’t think there is any chance that they could have added any more stimulus, remember that back in April when the sales tax was instituted, Kuroda said that they would be ready to potentially DOUBLE their current allotment. So needless to say, there could be a lot more where that came from on its way in the future.

Tuesday, November 25, 2014

2:00 GMT Conference Board’s Chinese Leading Economic Index

• The ECB and BoJ aren’t the only monetary entities on the easing cycle as the People’s Bank of China made waves this past week with a surprise cut to its deposit rate. Fears of a Chinese slowdown have pervaded markets for years, but haven’t yet come to fruition. By cutting rates, the PBoC is indicating that they aren’t happy with the status quo and may even be fearful of a slowing economy. In addition, the PBoC often operates a little ahead of the curve considering the Chinese government’s propensity to massage data to make things look better for themselves. Therefore, we may see some Chinese data misses in the coming weeks, and where better to start then the Leading Index? If this does miss, watch out for a drop in China-dependent currencies, particularly the NZD, which has also been battling declining milk prices and a central bank that is shifting from hawkish to neutral.

9:30 GMT BBA UK Mortgage Approvals (October)

• Each of the last three releases from this report missed expectations and revised the previous reading lower. That’s a double whammy for a currency that has been searching for good news in the wake of disappointing data across the board. Beliefs that the Bank of England would be one of the first major central banks to raise interest rates are fading about as quickly as Tiger Woods’ golf game, and it appears jolly old England won’t be able to escape the residual effects of a slowdown in the Eurozone. Beware of another negative mark in this release that won’t give much relief to the GBP.

Wednesday, November 26, 2014

9:30 GMT UK Second Estimate Gross Domestic Product (Q3)

• Due to the simple fact that we’re mentioning Mortgage Approvals and the 2nd release of GDP for the UK this week, you can probably tell that there aren’t a lot of compelling news releases scheduled this week. Regardless, there is a possibility that this figure could be different than the first iteration. The first figure showed a 0.7% increase for Q3, so that is likely to be repeated, but any change higher or lower could influence the GBP in that particular direction.

13:30 GMT US Personal Consumption Expenditures (October)

• After enjoying relative obscurity over the first few years after the Great Financial Crisis, inflation (or lack thereof) has returned to a position of importance. While many economic observers place a lot of faith in the Consumer Price Index, PCE is the one that the Federal Reserve considers their favorite. Unfortunately for those who would like to see the Fed raise interest rates soon, this measure of inflation has only declined since its 2014 high water mark of 1.8% back in May. On the other hand, the 1.7% CPI read on expectations of 1.6% this past week is a positive sign that inflation could be turning back toward the Fed’s 2% target.

13:30 GMT US Durable Goods Orders (October)

• This is one of the most volatile and unpredictable economic releases in the US, and the failure of consensus to nail it down makes it a very market-moving release as well. Expectations are calling for a 0.7% decline, which would constitute a third straight negative result if realized. However, this metric hasn’t had three straight negative months since late 2011, and considering the big drop off of -18.3% a couple months ago, there may be a bounce back to good and another boon for USD bulls.

15:00 GMT US New Home Sales (October)

• So far this month, US housing reports have been encouraging: Building Permits, Housing Starts, and Existing Home Sales all had strong showings and portend well for New Home Sales. However, last month’s release has left a bit of a bad taste in the mouths of traders as it missed consensus AND the previous month was revised much lower than originally reported. A bit of a bounce back may be in store, but considering all of the good USD news of late, simply a small beat or a meeting of expectations may not be enough to spur any new fervor. Therefore, this may have a negative effect on the USD even if there is no good reason to be disappointed.

21:45 GMT New Zealand Trade Balance (October)

• The Kiwi nation is highly dependent upon the milk trade, and according to the dairy index, that industry is not doing so hot right now. Prices have been declining, which likely means that trading in the commodity has been dwindling, and that’s a very bad thing for NZ trade balance. Last month’s deficit (-1350M) was the largest seen since at least 2007, and it may not get much better from here. Also, the slowdown in China could have its tentacles grinding the gears in the NZ economy as well. Therefore, this one may not turn out so well for the NZD.

Thursday, November 27, 2014

Thanksgiving Day (US)

Friday, November 28, 2014

0:30 GMT Australian Private Sector Credit (October)

• There hasn’t been too much deviation away from the norm in this release over the last few months as it has oscillated both above and below the 0.5% level, but once again, the issues in China may have some impact. The consensus is expecting a 0.5% increase this time around as well, so there may be some over-reaction if it doesn’t live up to the standard. Strangely enough, the Reserve Bank of Australia may not be too upset over that reaction as it believes the AUD is overvalued anyway.

10:00 GMT Eurozone Preliminary Consumer Price Index (November)

• ECB President Mario Draghi has made it obvious that he believes inflation will only get worse and that his institution is unanimous in fighting that trend. This report is where the facts need to support the assumption in order for Draghi to proceed with his plan to bring QE to Europe. One could argue that the ECB already has QE in the form of Targeted Long Term Refinancing Operations (TLTRO, pronounced “TELL-tro”), but fighting the disinflation bug may require an outright QE program. Consensus is calling for a 0.3% increase YoY, which is depressing in its own right, but an even worse number could make QE a foregone conclusion.

13:30 GMT Canadian Gross Domestic Product (September)

• Canada’s economy has been surprisingly strong over the past month or so as employment was much better than expected, inflation is on the right track, housing is looking strong, and even consumer sales are rising more than anticipated. Last month’s GDP decline of 0.1% almost seems out of place in the grand scheme of things, so there may be a bit of a bounce back this month. Consensus evidently believes the same thing as it is calling for a 0.4% increase this time around. If any of the good vibe being produced by the US has any spillover to Canada, watch for this figure to either meet or beat consensus and provide a spark for the CAD.