SHORT EURUSD: MISPRICING ECB & FED POLICY/ FUTURE POLICY/ BREXITThe Gross underpricing of ECB and FOMC Monetary Policy Changes - A fully-priced medium-term equilibrium Lower coming?
EURUSD:
*Short EURUSD 3m-12m Duration: 1/2lots @1.11 - 1.07TP1; 1.04-5TP2 1.01TP3
1. On Decemeber 2nd the ECB cut their rate by 10bps to 0.05%, paradoxically this actually caused EURUSD to rally higher. Thus this is a mispricing as Reductions in CB interest rates send currencies lower as 1) it reduces the demand for the currency as hot money flows, seeking higher rates, falls and; 2) Increases the Supply of the currency as at lower interest rates, banks borrow more and lend more, which in turn (through the bank/ credit multiplier) increases the EUR money supply.
- So reduced demand + increased supply = EUR should have a lower value, so EURUSD should have fallen. Instead EURUSD actually rallied 350pips higher to 1.095 on the day - so this policy action has been underpriced
- Though it should be noted that the reason EURUSD didnt fall was because going into the Dec ECB meeting expectations of Draghi were priced at 15-20bps of cuts so since he "failed" the market reacted hawkishly/ buy EUR.
2. On Dec 16th the FOMC increased their rate by 25bps to 0.50%. For the same, but opposite, reasons above this leads to increased USD demand and reduced supply.
- so the net impact should be aggressively increased USD strength, however, EURUSD only fell by some 100pips before days after erasing these gains to 1.08 back to 1.10 - so this policy action has been underpriced .
3. On March 10th ECB cut their rate to 0.00% or 5bps and extended their QE programme by several EUR100bn. This once again reduces EUR demand and increases EUR supply (even more so as QE is combined).
- So the net impact once again should be for EUR weakness to be priced in and EURUSD to trade much lower. However, once again paradoxically on the day EURUSD actually traded HIGHER? from 1.10 to 1.12 - so this ECB policy action is the third CB action to go UNPRICED in EURUSD
4. On the 24th of June the UK voted to leave the European Union in a shock Brexit vote - now given that it was a shock vote, EUR should have traded aggressively lower as one of its strongest countries voting to leave its economic union 1) weakens the E.Unions GDP/ Employment/ Inflation status as the UK leaves; 2) Causes uncertainty regarding the new trade agreements between the UK and itself, especially given that the UK is one of the regions biggest export markets; 3) causes uncertainty regarding other nations leaving - a run on the EU could develop.. currently several more nations have called for a vote.
- So all in all the Brexit result is negative for the economic stability of the Euro area and as a result this should reduce demand for EUR as investors fear the worst/ choose safer currencies. Reduced EUR demand should cause EURUSD to trade lower - it took a 200pip loss to 1.118 - 200pips of downside is not enough to price perhaps the most uncertain event possible for the EUR (800pips more suitable given UK is 16% of the eurozone).
