Eurozone remains at the front of traders' minds after Greek election

Macro Outlook

Over six years after “Helicopter” Ben Bernanke first showered the US economy with electronic money, the European Central Bank has finally engaged full blown Quantitative Easing. With the PR machine working perfectly, Mario Draghi was able to announce a programme of €60bn asset purchases per month over an 18 month period (leaks had suggested €50bn over 2 years) to ensure the market was duly impressed. After initial contemplation during the press conference, traders gave Draghi full marks (euro down, sovereign yields down, stocks up). Historically, QE has been excellent for equities and has been able to pull interest rates lower. But with the yield curve on German debt already significantly flattened in the past few months (maturities up to the 5 year Bobl already yield negative), it will be interesting to see how much is already priced in; also whether the impact is felt in the real economy and the transition mechanism feeds through to the man on the street. Immediate concern though lies with how traders react to news that elections in Greece have been won by the anti-austerity Syriza party. This victory which could ultimately result in a default on over €300bn of debt with a potential first exit from the Eurozone. Reaction to a possible “Grexit” could shape markets this week.

Must watch for: Federal Open Market Committee rates decision

Impact: According to the market’s interest rate futures, the Fed is now the only major central bank that remains on course to begin a tightening cycle in 2015. The comments from the Fed will be interesting seeing as its recent confidence in the US economic recovery and the lack of impact from falling oil prices have suggested the US is now a standout performer in terms of global economic recovery. With the dollar so strong recently, forex markets will be especially responsive if there is a change to the tone towards the doves again. Equity traders will also be on alert.

Foreign Exchange

Consolidation in the forex majors gave way to a series of sharp moves last week with the dollar being the main beneficiary. The ECB expanding its monetary easing to €60bn of purchases per month significantly impacted on the euro as the single currency weakening to lows not seen since 2003. However the ECB was not the only central bank to engage monetary easing last week, as the Bank of Canada unexpectedly cut interest rates by 25 basis points. After minutes from the Monetary Policy Committee showed a lurch back towards the doves at the Bank of England, the Federal Reserve is now a lone ranger on the path towards monetary tightening. This continued divergence in monetary policy means that the US dollar should continue to make strong gains against major currencies. The Dollar Index broke out to an 11 year high after the ECB’s move, whilst the Swiss franc is the only currency to outperform the dollar over the past few months (that is if you do not count gold and silver as “currencies”).

WATCH FOR: US economic data dominates the calendar next week and the FOMC statement should be the pinnacle of the action, with US GDP running in a close second. Sterling traders will be looking out for the UK GDP data, whilst euro traders will be focused on flash CPI firstly from Germany and then the Eurozone.

Indices

The advent of the ECB extending its monetary easing has driven Eurozone equity markets strongly higher. With a €1.1trillion balance sheet expansion by the ECB up to September 2016 will need to go somewhere and QE programmes in other countries in recent years (ie. US, Japan and to some extent the UK) show that equity markets tend to be a prime location for the funds. So the German DAX, the French CAC and other markets such as the Italian FTSE MIB have all shot higher. In the case of the DAX a huge breakout to all-time highs could now continue, although be mindful that even in QE driven markets there is still time for a near term correction. The S&P 500 seems to still be trying to shake off the early January blues, but focus will increasingly be on earnings season now the ECB is out of the way. Although volatility has dipped in recent days and this should only be to the benefit of equity markets, with a clear negative correlation between the S&P 500 Index and the VIX Index of S&P 500 options volatility. In recent days the FTSE 100 has been reactive to the signs of support in the oil price and a (possibly near term) support formed on the copper price (helping to support the heavy weighted oil majors and basic resources), however signs of a breach of support would hit the FTSE 100 once more.

WATCH FOR: The continued correction in equity volatility indices such as the VIX reflecting a market sentiment improvement. The FOMC statement is the main event for US equities as it will show how committed the FOMC is to tightening. GDP data for UK and US will impact the FTSE 100 and Wall Street.

Other Assets: Commodities & Bonds

The oil glut in supplies remains a big reason behind why the oil price remains anchored and the bulls have been unable to gain any real traction. Last week the US crude oil inventories reached record levels and reflects the on-going issue with oil supplies. There is still little sign from OPEC that supplies will be cut there either. The death of King Abdullah of Saudi Arabia briefly spiked oil higher on the prospect of a change in stance on production, but this was quickly snuffed out. That said though, there is still a two week support holding suggesting at least stable levels of demand.

The engagement of quantitative easing by the ECB has seen Eurozone bond yields plummet even lower. With €60bn of purchases to be put through a month expect yields to remain on this downward path for the foreseeable future. The US 10 year yield is still strangely anchored and is struggling to gains upside traction which suggests the market is still not entirely convinced by the recovery path and the prospect of the beginning of the Fed’s tightening cycle which is currently priced in for Q4 this year.

WATCH FOR: The FOMC monetary policy statement to drive Treasury yields this week, with further pressure on Eurozone CPI to impact on sovereign yields in the Eurozone. GDP data will impact on oil.