Volatility remains high as markets bet on ECB QE this week

Macro Outlook

On Thursday the Swiss National Bank (SNB) sent shockwaves through the forex markets. On a staggering day that will go down in history, the SNB abandoned its policy of maintaining a floor of €1.2000 on Euro/Swiss. The timing of this decision is not insignificant, coming a day after the European Court of Justice advised that the European Central Bank’s promise of Outright Monetary Transactions are not contravening the law of the European Union Treaty, which prohibits the direct financing of states. This effectively means that as long as the ECB sticks to the secondary market, it can purchase all the sovereign debt it takes. The decision also removes a key hurdle for further ECB easing. With the Eurozone falling into deflation, Mario Draghi recently suggested that ECB staff have been told to prepare for additional unconventional measures (rumoured to be sovereign debt purchases on a proportional basis of countries’ net contributions), the SNB has clearly decided that the ECB is ready to move. A cap on the value of the Swiss franc (by purchasing euro denominated assets) would no longer be sustainable or affordable, hence the decision to remove the €1.2000 floor. Cue a 20% rally in the value of the Swiss franc. This is another lesson that tells us that the market will always win in the end.

Must watch for: ECB monetary policy & Draghi’s press conference

Impact: Actions of the SNB last week suggest they have decided that full blown QE from the ECB is inevitable and they cannot fight against it. So if is not a question of “if” then it must be a question of “when”. If not this Thursday then it would be at the March meeting, but suggestion is that ECB staff have been preparing a purchase programme of sovereign debt. The euro has already fallen enormously and despite this though there is room for further declines. This would also give equity markets such as DAX and CAC a boost. Quite what is would do for the economy is another question.

Foreign Exchange

To say that it has been an interesting past week in the world of foreign exchange would be somewhat of an understatement. Just looking at the markets side of the situation the volatility has been incredible. Thursday’s decision of the Swiss National Bank to abandon the floor of €1.2000 on Euro/Swiss and the subsequent strengthening of the Swiss franc will be talked about in text books for years to come, as Euro/Swiss fell over 3400 pips on the day. Currency volatility has spiked through the roof, whilst there have been significant moves seen on other major pairs too. As the Swissy soared on Thursday, the main casualty was the euro which plunged through yet more support levels against the dollar, with a move to a new low dating back to November 2003. The market has been busily pricing in the increasing prospect of sovereign debt Quantitative Easing by the ECB for several weeks now, but the decision of the SNB has seemingly all but put the rubber stamp on it and the euro has been punished. Market sentiment is making an impact too on majors. As the oil price has found support, traders are moving away from safe haven plays such as the yen. Recent gold strength has also benefitted the Aussie dollar as well. Expect the commodity currencies to react to Chinese growth data too this week.

WATCH FOR: Early focus on Chinese GDP which will impact risk sentiment for commodity currencies (Aussie, Kiwi and Loonie), whilst Thursday’s ECB announcement could be ground breaking for the euro.

Indices

Anyone who was looking for a nice quiet start to 2015 will have been disappointed as equity markets continue to fly here, there and everywhere. Volatility as measured by indices such as the VIX remain elevated and with the huge fundamental drivers continuing to impact on sentiment (oil and copper price weakness, the SNB and the prospect of further ECB easing) there appears to be little on the horizon with which to settle markets down. Earnings season has kicked off in the US and it has not been overly encouraging for the big banks. On Friday, Goldman Sachs, Citigroup and Bank of America joined JPMorgan in disappointing the market. However, the recent declines on Wall Street have come in contrast to that of the German DAX. All signs are increasingly pointing towards the ultimate easing action being taken by the ECB in Thursday’s meeting and German stocks have reacted accordingly as the index pushes within range of the all time highs again. The FTSE 100 remains bogged down by the large weighting in oil majors and basic resources, which collectively make up around 28% of the market cap of the index.

WATCH FOR: Continue to watch volatility indices which if they start to fall it would signal improved sentiment. Earnings season in the States usually is a big driver of US markets. However major impact on Eurozone markets could come if the ECB engages full blown QE this week.

Other Assets: Commodities & Bonds

The impact the oil price still has on market sentiment remains high and a key question everyone wants the answer to is when oil will reach a bottom. Indications of falling supply would certainly be a good sign and this week the International Energy Agency cut its 2015 non-OPEC production growth by around a quarter. This helped to generate an element of support last week. If we begin to get reports of demand also picking up then sustainable support could begin to form.

Amidst all the market volatility, accentuated by the moves of the SNB on Thursday has meant that the demand for safe haven assets has driven investors towards the cushion of sovereign debt with US Treasuries and Gilt reaching record lows. Whilst expectation is high for the ECB to engage a full blown programme of sovereign debt purchases the yields on German French and Italian debt continue to also fall. It is likely this week could be rather volatile as we approach the ECB meeting on Thursday. Something tells me that jawboning by Mario Draghi will not cut it this time. It is time for him to walk the walk.

WATCH FOR: China GDP will have an impact on oil due to the implications on demand. The major news will be whether the ECB engages full blown QE which could mean a volatile week for both oil and bonds.