The ECB Steps Up to the Plate

The main event today is the ECB meeting.  Many observers expect a dovish tilt as Draghi prepares to expand QE in December.  A Bloomberg survey conducted last week found that 80% of economists expect the ECB to eventually do so, with 56% expecting it at the December 3 meeting.  The survey found 86% expect a move by the end of Q1 2016.  Every central bank that has tried QE has had to do more than initially anticipated.

The main event today is the ECB meeting.  Many observers expect a dovish tilt as Draghi prepares to expand QE in December.  A Bloomberg survey conducted last week found that 80% of economists expect the ECB to eventually do so, with 56% expecting it at the December 3 meeting.  The survey found 86% expect a move by the end of Q1 2016.  Every central bank that has tried QE has had to do more than initially anticipated.

Although the ECB has introduced formal voting mechanism, the institution still seems to be driven by consensus.  Such a consensus does not exist presently.  Nearly every official that has addressed the topic appear to be still by in a “watch and wait” mode.  Another input is the survey of professional forecasts, which will be released tomorrow.  A downgrade of growth and inflation forecasts could fan expectations that the ECB’s staff revises its forecasts lower in December.  The change in expected economic outcomes is a necessary precondition to changing policy. 

The flash PMI will also be released tomorrow.  The composite reading is expected to slip toward 53.4 from 53.6.  It is not the small decline that is important, it is that such a reading would be the lowest since February, the month before the ECB’s asset purchases began.

The most likely action is thought to be extending the already soft termination date of September 2016.  This seems to be the path that is most likely to form the basis of agreement.  Draghi often warned that it is not a hard and fast terminal date; that the importance was achieving the objectives.  This would seem to be the alternative least objectionable by those that were never keen for QE in the first place.  It arguably may not be the most effective course, but that is politics – the art of the possible. 

The Federal Reserve’s third (final?) version of QE was open-ended in terms of duration as is the BOJ’s current program.  The ECB seems to hope that fiddling with the duration could impact expectations.   We are skeptical about the significance of it in this context.

We suspect that the event risk of the ECB meeting itself, and ideas that Draghi will be dovish has weighed on the euro since the middle of last week.  Yesterday we suggested that slippage into the $1.1320-$1.1330 would likely contain downticks, and that euro can recover into the $1.1400-$1.1425 area.  In Asia, the euro has in fact bounced off $1.1330.  The near-term upside target still seems reasonable.  

The two caveats that we would add are the weekly initial jobless claims that US reports and the 2-year interest rate differential.  The weekly jobless claims show no deterioration of the labor market that would confirm the past couple of nonfarm payroll reports.  US recessions do not take place when weekly initial jobless claims, even when using a four-week moving average to smooth out the noise, makes new cycle lows.

The US premium over Germany on two-year money fell from 103 bp in mid-September to almost 80 bp in mid-October.  It has since firmed and is pushing above its 20-day moving average for the first time in a month.

Double-D as in Draghi`s Day is republished with permission from Marc to Market