Will ECB prepare markets for a rate cut?
Fawad Razaqzada June 6, 2019 6:20 AM
Ahead of the publication of the ECB’s latest policy statement and President Mario Draghi’s press conference, the euro was largely out of favour this morning after it reversed sharp gains to close lower yesterday. Stocks were still buoyed by increasing signs that central bank policy outlook has taken a decidedly dovish turn.
Investors will be paying close attention to the European Central Bank’s tone and indications on interest rates outlook today. Ahead of the publication of the ECB’s latest policy statement and President Mario Draghi’s press conference, the euro was largely out of favour this morning after it reversed sharp gains to close lower yesterday. Stocks were still buoyed by increasing signs that central bank policy outlook has taken a decidedly dovish turn.
Will ECB join race to the bottom?
Nearly all major central banks have made U-turns on interest rates over the past few months, dropping their previously hawkish stances in favour of more expansionary outlook and the ECB will be no different, in our view. Although no change in interest rates is expected at this meeting, some market participants clearly anticipate that the ECB will be preparing the markets for a potential rate cut at some point down the line, possibly early next year. Just a few months ago, they were contemplating on an interest rate hike after the end of this summer. However, things have changed for the worse in recent months, with protectionism on rise, the global economy slowing down and there is still no light at the end of the Brexit tunnel. Meanwhile renewed weakness in crude oil is likely to be an additional disinflationary factor that policymakers at the ECB would be taking into account.
How will the market react?
But as always, it is the market’s reaction that will be more important than the news itself. It is reasonable to expect that some shrewd investors will already be anticipating the ECB to deliver a dovish outlook on the economy and interest rates. So, some of the ECB’s likely dovishness may already be priced in and therefore we might not see too much of a reaction in the euro or stock markets. Indeed, the bigger risk as far as the markets are concerned is the event the ECB turns out to be surprisingly less dovish than expected. Now that would be a real surprise given the cooling of inflation and anaemic growth in the Eurozone, not to mention ongoing Brexit and trade uncertainties.
German-Japan yields narrowest since April 2015
Among the euro crosses that we will be watching during and after the ECB presser will be the EUR/JPY given the recent narrowing of the gap between German and Japanese yields. In fact, the 10-year German bunds are yielding lower than the equivalent Japanese debt, with the gap falling below zero. At -0.109 currently, the gap is at its narrowest since April 2015 and it could shrink further should the ECB deliver a particularly dovish message today.
Source: TradingView and FOREX.com.
EUR/JPY trends lower inside bearish channelAs far as the EUR/JPY is concerned, well this pair has been trending lower like the abovementioned yield spread and is currently residing in the middle of its bearish channel, hovering around 121.50 support. A clear break below this level could pave the way towards the lower support trend of the channel and possible the January flash crash low at 118.80. However, in the event rates break out of the channel at 112.25 and hold above, then in that case we could see a reversal in the bearish trend.
Source: TradingView and FOREX.com.
Disclaimer: The information on this web site is not targeted at the general public of any particular country. It is not intended for distribution to residents in any country where such distribution or use would contravene any local law or regulatory requirement. The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
Futures, Options on Futures, Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Losses can exceed your deposits. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex and commodity futures, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that we do not provide any investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. References to Forex.com or GAIN Capital refer to GAIN Capital Holdings Inc. and its subsidiaries. Please read Characteristics and Risks of Standardized Options.