The probability of Draghi confirming tapering is quite low


The BoJ and ECB meet this week but already expectations for the ECB are being reined in. The Fed doesn't meet again until July 25-26. We might get some cheerful data from housing this week, the Homebuilders Housing Market Index tomorrow (sentiment) and June starts and permits on Wednesday (hard).

Also on the agenda is the second round of Brexit talks in Brussels. They will talk about the European Court of Justice, among other things. Bloomberg writes, tongue-in-cheek, that Brexit seems to have ended talk of a European financial transactions tax now that everyone is jockeying to poach banking from London.

US CPI and retail sales on Friday revived the narrative that the Fed may stay its hand at the Sept FOMC, but offsetting that dollar-negative view, they are also considering Draghi's comments after the ECB meeting this week more realistically. The probability of Draghi confirming tapering is quite low. This sets up tension in the euro/dollar that can jiggle it in both directions.

Bloomberg has a story about a Credit Agicole analyst who devised a formula for ECB tapering, named a "new generation" Taylor rule. Here it is:

Monthly net injection from the ECB in billions of euros (QE +TLTROs) = 120 x (1.5 - core inflation).

The important number is 1.5, which is the percentage growth rate of inflation before weakness set in about 2013. The 120 is a multiplier derived from the three main instances of changes in the amount of QE. Applying these assumed factors, the analyst gets a forecast of a reduction in monthly purchases to €35-40 billion at the beginning of next year, falling to €20 billion from July and ending QE by end- 2018. Here is the chart:


We imagine Draghi laughed out loud when he saw this. First, it's brilliant and entirely logical. But second, it assumes everything goes as expected. Third, it assumes no Event Shock. Models always depend upon assumptions, of course. Here we have three unknowns, the multiplier, the base-case inflation of 1.5% and the upcoming core inflation forecast. That's an awful lot to assume. This is not to deride the formula. The outcome as shown in the chart is entirely consistent with what traders and analysts are now expecting. And there may lie the rub. Not exactly confirmation bias, but something like it, as in the multiplier of 120 reflecting past QE decisions, some of which were dead wrong (one was horribly late). A bigger multiplier would have tapering progress far faster, while a smaller one will drag it out. If we were betting, we'd put a dollar on dragging out.

As for the dollar forecast—expect the least likely outcome. US inflation looks weak and traders in more than one sector jump to the conclusion the Fed will be discouraged from the next hike in Sept. In fact, they have already pushed out the expectation to December. But despite Yellen insisting the Fed is datadependent, we are not so sure the market is looking at the same data as Yellen, or over the same forecast horizon. If doubts begin to creep in, we could see the euro slide back to red support at around 1.1398.

Politics: Vanity Fair can be counted on to deliver juicy political stories. This time it has one on the toxic influence of Roy Cohn on the mind of Donald Trump, who seems to have forgotten Cohn was eventually disbarred. One thing Cohn taught Trump was to attack his accuser and to counterattack immediately and relentlessly—and to claim victory even when it's obviously untrue. In other words, Cohn taught Trump to lie.

The other story is about the "enablers," those craven Republican leaders who are sticking with Trump to get their own agenda moved forward. Ryan, Priebus, Cruz, McCain, McConnell and even Graham each have a dog in the fight. Here's the last paragraph: "Donald Trump will suffer his own grim fate in the eyes of historians, but it will come with an asterisk: he is a profoundly damaged human being with no true understanding of his capacities, his emotions, his ignorance, his job, or the fundamentals of hu-man decency.

"His enablers will get no asterisk. They will be treated with the special contempt reserved for those who acted knowingly and cravenly, with eyes wide open."

As Nate Silver observed a few months ago, the effort to get rid of a president absolutely requires the leaders of his own party to gang up against him. In Nixon's case, it was Goldwater, among others. Who might it be in Trump's case? This doesn't mean we won't get tax reform but it might mean we also get impulsive lashing out against allies and neighbors to distract and divert attention.

Currency Spot Current Position Signal Date Signal Strength Signal Rate Gain/Loss
USD/JPY 112.46 LONG USD 06/21/17 WEAK 111.09 1.23%
GBP/USD 1.3065 LONG GBP 06/28/17 WEAK 1.2701 2.87%
EUR/USD 1.1463 LONG EURO 06/28/17 STRONG 1.1218 2.18%
EUR/JPY 128.92 LONG EURO 06/27/17 WEAK 125.73 2.54%
EUR/GBP 0.8774 LONG EURO 04/25/17 STRONG 0.8490 3.35%
USD/CHF 0.9626 SHORT USD 06/28/17 WEAK 0.9675 0.51%
USD/CAD 1.2655 SHORT USD 05/17/17 STRONG 1.3621 7.09%
NZD/USD 0.7331 LONG NZD 05/30/17 STRONG 0.7062 3.81%
AUD/USD 0.7822 LONG AUD 06/08/17 STRONG 0.7548 3.63%
AUD/JPY 87.97 LONG AUD 06/16/17 WEAK 84.65 3.92%
USD/MXN 17.5465 SHORT USD 05/17/17 STRONG 18.7098 6.22%
USD/BRL 3.1794 SHORT USD 07/17/17 NEW 3.1794 0.00%

This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.