European Central Bank Preview – Time to PivotDespite facing the unknown external shock of a war, the Eurozone economy’s growth has been resilient in the first three quarters of the year. Eurozone Gross Domestic Product (GDP) rose by 0.3% quarter-on-quarter (QoQ) in Q3, easing from a 0.8% increase in Q2 2022 aided by the rise in government spending alongside an improvement in inflation adjusted trade surplus . However, this is likely to change in Q4 2022 and Q1 2023 as COVID reopening demand fades.
Eurozone recession remains a key risk until Q1 2023
Europe is set to embark on a harsh winter, and with savings rates extending the decline from a 1.7% drop in Q2, consumer spending is likely to come under pressure. The 1.8% month on month falls in euro area retail sales in October is consistent with the notion that real income squeeze is now catching up the with consumers. Services spending rose only 1.5% in Q3 compared to the 3.1% jump in Q2 2022 . The labour market has remained fairly resilient as Eurozone unemployment hit a new low of 6.5% in October, pushed down by falling unemployment in Southern Europe, the Netherlands, Finland and Austria. However, unemployment is likely to rise as the economic slowdown and tightening financial conditions impact hiring. That being said, fiscal policy could come to the rescue as major Eurozone governments have earmarked €573Bn into the economy to shield the private sector from the upcoming fallout in economic activity.
Inflation in the Eurozone declined more than expected from 10.6% in October to 10% in November. Yet it’s hard to say for certain that the inflation rate has passed its peak as it is largely dependent on the fluctuations in energy prices. Core inflation remained at 5% in November and is likely to remain close to 5% through Q1 2023 . Companies continue to transfer higher input costs to consumers and in spite of an approaching recession, we expect this process of cost-push inflation to extend into 2023, keeping price pressures higher for longer.
European Central Bank (ECB) split between the doves and hawks
Ms Isabel Schnabel (a member of the executive board of the ECB) warned in November that loose fiscal policy risks adding to underlying inflation pressures by boosting consumption and reducing the incentive for consumers and businesses to save energy. We would argue that while the volume of relief packages is large, they are insufficient to provide complete relief for all consumers and companies. Ms Schnabel also noted that, “that the room for slowing down the pace of interest rate adjustments remains limited, even as we are approaching estimates of the ‘neutral rate’”.
This hawkish sentiment was echoed by Dutch central bank head Klaas Knot in his statement that risks are tilted towards the ECB doing too little to combat rising inflation, noting that an economic slowdown, or perhaps even a recession, is needed to bring inflation under control. President Lagarde stressed that she would be surprised if inflation has already peaked, as there is too much uncertainty regarding the pass-through of high energy costs at the wholesale level into the retail level. She added that the ECB may have to go into restrictive territory with key rates. On the other hand, the head of the French central bank, Villeroy, who has often anticipated the actual ECB decisions in his statements, spoke out in favour of 50 basis points. Even hawks such as Bundesbank President Nagel and Estonian Mueller seem to be able to come to terms with a hike of just 50 basis points.
Further clarity on Quantitative Tightening (QT)
The ECB is likely to meet consensus expectations this week of narrowing the pace of rate hikes to 50Bps on 15 December, following two 75Bps rate hikes in September and October. This decision will lift its deposit and refinancing rates to 2% and 2.5% respectively. Neither peaking inflation nor a recession will give the ECB a reason to hold back from raising rates in Q1 2023, but both suggest that risks are tilted towards a slower pace of tightening. The outlook for the balance sheet, and more specifically QT, will be another key theme at this week’s meeting. It will be interesting to see whether the ECB will be pressed to sell bonds outright or stick with roll-off. We would expect the central bank to begin with an Asset Purchase Program (APP) roll-off equivalent to a monthly reduction of €25Bn in the balance sheet on average. Currently the ECB is still using Pandemic Emergency Purchase Programme (PEPP) reinvestments to compress spreads and the Transmission Protection Instrument (TPI) remains at its disposal if conditions deteriorate further. Both these tools limit how far the ECB can go with QT.
Sources:
1Eurostat as of 30 November 2022
2National Accounts as of 30 November 2022
3Bruegel as of 31 October 2022
4Bloomberg as of 30 November 2022
Tltro
VIX: Record net-short options (fundamental analysis)Although we primarily trade FX contracts, staying on top of the equity markets around the world can have huge advantages when trying to identify opportunities preparatory to them even showing validity. The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options.
Put simply, this chart represents volatility in the most widely used benchmark in equity markets (SPX). As you can see, over longer term time frames price has compressed. This can be proven by looking at the average true range indicator (ATR) and historical range percentage indicator (HRP) on the daily timeframe. You will see levels very low; significant because the last time these two indicators were this low on the daily chart the VIX was prior to big spikes in volatility. These are incredibly complacent and quiet markets. There's nothing wrong with equity markets hitting new highs, however the more risk-appetite that traders have in their books and the further it deviates from what we would construe as a well founded risk position. Traders are carrying assets this high up in the market know that their exposure at these prices is risky. This is more of a risk when you consider the representation of volatility seen in the chart above.
Looking at futures for the VIX, there is a net short position on the derivatives currently not expired. What's significant though is that the amount of contracts net short is 218,000 a new record. This shows the willingness of the market to take on risk through leverage. Keep in mind, the amount of free cash for Wall Street is at record lows, as the complacency of it itself can be seen just by considering this fact.
Gold to fulfill Daily Structure through 1500?This chart is very simple for a reason; to show how easy and simple a historically successful strategy can be to execute and create. There are alot of confluences not included in the chart so keep that in mind. Ahead of CPI numbers, we'll be looking for an opportunity to long gold. We won't be interested in trading the news, only the reaction. This trade will be published to our telegram channels.
The ECB, Brexit, the Fed and capital flight from the RFThere were no particularly strong movements in the foreign exchange market on Wednesday. So let us analyze the main events of yesterday.
The ECB left the rate unchanged. The Draghi conference was perceived by the markets quite cool, at least judging by the dynamics of the euro. Although the head of the ECB did not say anything new. He noted that the output data remains weak. As for the details of the TLTRO program, they will be announced later and will depend on the economic situation. So we see no reason to change our recommendation on buying EURUSD from the current lower limit of the medium-term range.
UK Macroeconomic statistics appeared quite good on Wednesday. GDP turned out to be better than analysts 'forecasts (0.2% m / m with a forecast of 0% m / m) in February, industrial production was also higher than experts' expectations (+ 0.6% m / m with a forecast of +0.1). However, the reaction of the pound was quite restrained. The reason for this is the expectation of the EU Brexit decision. As we expected the EU gave Britain a Brexit delay on its own terms.
Brexit delayed until October 31. Such decision had no significant effect on our position. We will continue to buy a pound on descents. It is not necessary to wait for the pound growth in the foreseeable future above 1.40. In any case, it will not be boring. May still needs to convince Parliament that such a long delay is justified, so you should not relax.
Another important event on Wednesday was the publication of the minutes of the last FOMC Fed meeting. Despite the good dynamics of the US economy, the Fed sees a significant amount of risk from the outside. Accordingly, interest rate decisions will directly depend on the state of both the internal and external influence. At the same time, the Fed is prepared both to raise the rate and lower it. Well, while in conditions of uncertainty, the best option is to keep rates at current levels. Our position on the dollar remains unchanged - we are looking for points for its selling on the intraday basis.
We continue to talk about the ruble. The urgency of this increases with its attempt to grow. So yesterday, the ruble continued to strengthen, and we consider it our duty to recall why this is temporary and why it is worth selling. Yesterday we already wrote about a 10 trillion hole in the Russian banking system, and today we will talk about capital outflow from Russia.
According to the data of the Central Bank of the Russian Federation, the net outflow of foreign investments from the authorized capital of Russian companies of non-financial sector rose to $ 6.5 billion last year, which is a record value in the entire history of statistics since 1997. Against this background, Goldman Sachs released their forecast for the actions of the Central Bank of the Russian Federation in terms of the discount rate. Goldman analysts are expecting it to drop to 6.5%: in 2019 twice, each time by 25 basis points, and another three times by 25 basis points, that is 75 basis points, in 2020.
All this is definitely a bearish signal. They do not relate to immediate factors, but these are the things that determine the fundamental value of an asset. In this case it is the Russian ruble. So we continue to recommend its sales.
Is it a bird? Is it a plane? is it a channel!?Are we just bouncing off walls here? It seems like we might be... Other convincing ideas here () suggest this is the end of a regression at the .618 fib following the bullish run from the start of 2017. I like it either way you cut it.
However we look, after quite a predictable and profitable short position before the heavy sell-offs yesterday we find the market rallying north. I for one am taking some profits at the halfway line but if we keep breaking through resistance levels with such convincing aplomb I might try and ride the waves all the way to the channel's edge. Now wouldn't that be nice.
Key US data today has helped a couple of big upticks. EU 'dovishness' and unexpected TLTRO reports in the commentary yesterday has also had a convincing effect which may be amplifying technical analysis, but it is unlikely to be masking it altogether given the continued trends.