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ECB Press Conference Bullet Points

Written by A Forex View From Afar on Friday, January 16, 2009

• The Governing Council decided to reduce the interest rate on the main refinancing operations of the Euro system by a further 50 basis points
• Since September 2008 the financial market turmoil has intensified and broadened
• Tensions have increasingly spilled over from the financial sector into the real economy
• Foreign demand for euro area exports has declined, and euro area domestic activity has contracted in the face of weaker demand prospects and tighter financing conditions
• The survey data and monthly indicators for November and December clearly point to a further weakening of economic activity around the turn of the year
• The Governing Council continues to see global economic weakness and very sluggish domestic demand persisting in the coming quarters as the impact of the financial tensions on activity continues
• Outlook for the economy remains surrounded by an exceptionally high degree of uncertainty
• Overall, risks to economic growth remain clearly on the downside
• Annual HICP inflation has declined substantially since the middle of 2008
• The significant decline in headline inflation in the second half of 2008 reflects mainly the sharp falls in global commodity prices over the past few months.
• Lower commodity prices and weakening demand confirm that inflationary pressures in the euro area are diminishing
• Headline annual inflation rates are projected to decline further in the coming months, possibly reaching very low levels at mid-year. Inflation rates are expected to increase again in the second half of the year
• Risks to price stability over the medium term are broadly balanced
• Unexpected further declines in commodity prices or a stronger than expected slowdown in the economy could put downward pressure on inflation
• The latest evidence confirms a moderating rate of monetary expansion in the euro area. Monetary trends therefore support the view that inflationary pressures and risks are diminishing.
• The broad aggregate M3 and, in particular, the components of M3 that are most closely related to the ongoing financial tensions, are stable
• The tightening of financing conditions resulting from the intensification of the financial tensions has contributed to a slowdown in the flow of monetary financial institution loans to the non-financial private sector in recent months
• The Governing Council recalls its operational decision, taken on 18 December 2008, to widen again the corridor formed by the rates on the Euro-system’s standing facilities as of 21 January 2009
• Looking forward, there is an expectation that inflation rates in the euro area will be in line with price stability
• Governing Council welcomes the European Council’s reconfirmation of its full commitment to sustainable public finances

Today’s conference press was probably the most bearish one in the ECB’s short-history. Mr. Trichet acknowledged that inflation pressures had further diminished in the last few moths, and now the Governing Council expects some very low CPI rates in the first part of the year. However, according to the bank’s assessment, this trend should reverse by the middle of 2009. In the Question and Answers session, Mr. Trichet said the Euro-area would not experience deflation, but only very low inflation rates.

The outlook for the economic activity clearly lies on the downside now. Both foreign and internal demands are very weak, affecting the Euro-area’s export market, and thus its trade balance. This trend is seen worldwide, and not only in Europe.
The most important key-points were in the Q&A session, and both were reflected in the market’s reaction. First, Mr. Trichet put a lot of empathy on the March ECB’s meeting, saying that the one in February is not so important, because of the short-time span of only 3 weeks. Shortly after, the euro started to move higher, until later, when Mr. Trichet said that the current rate of 2.00% is definitely not the limit, even though it is a very low rate. The euro started to tumble after this remark.

Also during the Q&A session, the ECB Chairman said that the transmission mechanism between the bank’s decision and the real economy throughout the 3M Libor rate, declined significantly in the near-term. In addition, Mr. Trichet has said that the ECB staff projections are going to be lowered at the March meeting, adapting to the current economic conditions.

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Preparing for the ECB

Written by A Forex View From Afar on Wednesday, January 14, 2009

On Thursday, the financial markets await the ECB’s reply to the credit crunch. Currently, most estimates run for a 50 basis points rate cut, down to 2.00%.

Earlier this month, the financial markets speculated that, the ECB would vote for a hold decision. This happened after Mr. Trichet said in a public speech that the recent rate cuts would still need time to be felt in the real economy. Usually, monetary policy needs between 6-18 months until they are fully passed on to the real economy.

However, some members of the Governing Council hinted that the bank would cut in January, but it is essentially to take actions in sectors other than monetary policy, where there is more room for maneuvers, especially fiscal policy. The comments of the Governing Council over the last few months indicate that the bank is reluctant to reduce the overnight rates too low, because of the broad implications in the financial markets, particularly in the inter-banking system. This was also underlined by Mr. Trichet by saying that the Fed and the ECB face different shocks, which require different solutions.

Mr. Trichet might hint during the press conference that the ECB will wait for additional data before taking a decision. If so, the euro will certainly rise. However, if there are no clear indications what the ECB might do next, and the Governing Council puts empathy on the risk to downside, the euro will take another strong hit. Using the Bundesbank model, the ECB is committed to prepare the market for its future actions (anchor expectations), and thus it might give important hints about future monetary policy actions..

This tactic was used a number of times during Mr. Trichet press conferences. This can be seen in the strong reactions the euro had to some conferences, while at others the euro simply traded in a tight channel, as in the attached chart. This was mostly seen in the last few months, when Mr. Trichet downgraded its assessment for the Euro-area economy.

ECB Interest Rate and the currency reaction

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A bleeding Q4

Written by A Forex View From Afar on Monday, January 12, 2009

The latest estimates for the three major economies, U.S., European and U.K. points to strong contractions in the fourth quarter of 2008.

Estimates are a 1.5% contraction in each of the three economies, in nominal terms, or 0.6% annualized. This would be the strongest contraction seen in the last few decades. In addition, both Q1 and Q2 of 2009 are seen negative next year, making this recession much longer than previous ones.

The very poor GDP forecasts should not be any surprise, since almost every release is at a record low, or very near. Manufacturing and industrial production, the two big components of the real economy contracted at the fastest speed on record in the last months, according to the PMI release.

The labor markets are also in a horrible state. The unemployment rate in the U.S. is now 7.2%, but forecasts go as high as 8.5%, even with President Elect Obama’s stimulus plan. The U.K.’s labor market trails very closely, having the rate rise by almost 1% since the summer of 2008. In Europe, the jobless rate rose steadily by 0.6% in the last year, reversing a downward trend that lasted more than 2 years.

With such poor forecasts ahead, it is wise to expect risk-aversion coming back into the market from time to time. The latest case was the NFP release, when the dollar strengthened more than 300 pips against the euro, after a very poor release. However, this is good news for currency traders, because we can enjoy strong (and profitable) trends. Risk-aversion can be a very good thing, as long as you are on the right side of the trade.

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Another Bank Has Failed

Written by A Forex View From Afar on Friday, January 09, 2009

Commerzbank is the latest bank that required government intervention to shore up its balance sheets.

The German government injected 18 billion euros, in two trenches, to save the bank, gaining 25 percent ownership plus shares. This means that under the German law, the bank has been nationalized. Commerzbank required 10 billion euros this week, after two months earlier the bank received another 8.2 billion euro.

Another bank failure should not be a surprise, however, because of the timing, it raises some eyebrows. From every point of view, financial markets have stabilized in the last few months, and even started to show some signs of improvements. Therefore how can the bank explain the sudden need for another 10 billion euros, when the bank’s capitalization is roughly 4 billion euros? Furthermore, central banks from around the world accept every possible asset the bank could produce at every hour of the day. The second question that the “bankruptcy” raises is how come the bank did not use any of the lending programs made special for such cases?

Maybe this was only one particular case, but since a number of banks said write-downs might resume in the first quarter, chances are we are going to see some other banks failing too. In such a case, it will be interesting to see the market’s reaction, since bonds, the usual safe-assets, are already at ultra-low levels.

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How much can the CPI fall?

Written by A Forex View From Afar on Thursday, January 08, 2009

The Euro-area CPI data has taken a deep plunge recently. During the summer of 2008, the CPI reached record highs, but has decline at a very fast pace during the past few months.

The Euro-area CPI dropped from a record 4.0% in June and July, to December’s unconfirmed number of 1.6%. This is a huge drop, but the question now is ‘how low can it actually drop from now on?

Theoretically, there is no limit to how much the CPI can fall, since it can go all the way below the zero benchmark. However, there is a practical limit to how low the inflationary read can drop.

In the last period, the CPI was dragged lower by huge declines in the crude oil market. At the same time, crude oil was to blame for the huge increases seen in the CPI during the early part of 2008.

Up to now, the month of January has brought something new in the crude oil market. The commodity managed to find a bottom, and actually posted some small gains. This means though, the CPI read might have found a bottom too, and the huge declines might stop, at least if oil does not move any lower.

As seen in the attached chart, crude oil (priced in euros) and the Euro-area CPI read moved hand in hand over the last five years. The correlation between the two, oil and Euro-area CPI, over this period is very high, slightly above 80%. Because the way the CPI is built, to absorb asset shocks over a longer period, it has the tendency to follow the oil market with a small lag.

OIL and CPI

Assuming that the oil market has hit the bottom, as most say it has, we can deduce the CPI read will not go any lower in Europe or in the other major economies. However, because of the CPI’s lag, we might see it coming down for a while, but soon the read will hit a bottom too, hopefully skipping any negative read.

If this holds true, central banks will not have the same initiative to cut interest rates, as they have up to this point. In Europe, the CPI read was the main reason why the central banks have cut so much, being in danger of “undershooting” the target. Maybe, no other bank will join the Fed and the BoJ in their quantitative easing path.

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The German Stimulus Plan

Written by A Forex View From Afar on Monday, January 05, 2009

The German government, led by Angela Merkel, is trying to propose a new stimulus plan in Germany meant to help the economy weather the financial crisis.

The new stimulus plan is projected to reach 50 billion Euros, or nearly $70 billion, over a two year time-span. Previously, the German government proposed a 12 billion euro, $17 billion, stimulus plan, over the same two year period, but was halted due to its small size. Even though there is not a clear destination for the money available throughout the plan, analysts estimate the biggest part of the funds would be used on public spending. In addition, some say the government might also reduce the tax level for low level incomes, to help internal demand pick up faster. It should be noted that, until now, Germany has opposed a common Euro-zone plan to fight the credit crunch.

From the available information, the German stimulus plan is significantly smaller than the one the U.S. government is planning to implement. The direct ratio is about 1:10 in favor for the U.S., since sources point out that Mr. Obama's proposed plan might reach as much as $700 billion. As a percentage of GDP, the U.S. plan is about 5%, while the German government’s plan represents nearly 2.1%.

Currently, the stimulus plan has had no direct implication on the currency market. However, as time goes by, this measure, correctly implemented, would help the German economy recover faster from the credit crunch. As such, it could have a direct influence over the euro's valuation, pulling it higher.

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Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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