A Summary of the key elements, lessons, ramifications of 2014's biggest market event yet, how to profit plus our "name the coming ECB QE" contest (QEU? QEZ? QEEU? QEER? QEGA?).
The following is a partial summary of the conclusions from the fxempire.com weekly analysts' meeting in which we share thoughts about key developments worth a special report, this one on the ECB's new stimulus package, coming full QE, and related lessons, ramification, guidelines on how to protect yourself and profit.
Those seeking more detailed analysis of each element of the plan, its impact, and how to protect yourself and profit ,should see the full report.
More Stimulus Coming
Draghi says more coming if needed. This bit of forward guidance was arguably the key item.
It Will Be Needed, So It Will Come
Obviously the ECB alone cannot fix the EU's problems. It's only a central bank (in many ways less powerful than most). It's not a government. All it can do is buy time for the politicians and policy makers, with more supportive policies. It can't replace the needed increased political unification not the widespread needed economic reforms which that integration would make possible. Heck even the bank union plan completed earlier this year still needs to be funded sooner, and be faster to deploy.
Given that its coming is only a matter of if, not when (for these and other reasons as we predicted back in January here).
Limits EUR Rally, Shorter Term Traders Need Watch For Verbal Intervention If EUR Rallies
It limited the short covering/buy the rumor sell the news rebound into the weeks' close and could do so in the coming week. Certainly it makes a break above the past 17 weeks' trading range unlikely. Even though no new measures are likely due for months, investors may well want to take some time to digest the move. Anticipated ECB attempts to "jawbone" the EUR lower should keep EUR bulls cautious. No doubt the ECB was hoping for further EUR weakness, and would like to contain the current rebound. The verbal intervention has already started, as ECB Executive Board member Benoit Coeure reminded France Inter radio on Saturday that ECB rates should remain lower than those of the US and UK in coming years.
Next: EU-Style Full QE (QEU, QEZ, QEEU, QEER?)
Although the ECB refrained from full quantitative easing - purchases of government bonds as undertaken by the Fed - it not only left that option open, the difference between full "out of the closet" QE and the new policies is more a matter of technical definitions than anything else. The ECB has begun outright expansion of the money supply, technical differences be damned, just as we predicted back in January, with (grudging) German acquiescence too. Out of the closet and into the strasse? There's just no choice if they want to buy time (unless they agree to GASP - take hard choices now? Naaah), and inflation fears have been drowned out by deflation fears.
· ---The end of the Secondary Market Program (NYSE:SMP) sterilizations is in itself a form of QE. The SMP was a way for the ECB to buy GIIPS sovereign bonds (and thus keep their borrowing costs down). The "sterilization program meant that for every euro the ECB spent on government bonds of Greece, Ireland, Portugal, Spain and Italy, it tried to withdraw an equal amount from banks by selling them interest-bearing deposits. As long as the ECB could sell enough of them to keep the money supply stable (it usually did), it technically avoided outright QE, to which the Germans objected as illegal and inflationary. With sterilization gone, and Germany accepting this move, the ECB is already engaged in a form of QE, expanding both its balance sheet and the money supply.
· ---Outright purchases of Asset Backed Securities (NYSE:ABS) are also a variation on QE. Accelerated preparation for this is thus another clear step towards a full QEU
· ---Draghi was clear in his comments that the ECB is not done. The only major step it can still take is some form of EU style QE, which we'll refer to as "QEU." There are many reasons it would prefer to leave this option for last, in addition to German objections to this policy. For example, another major reason is the sheer technical and political complications of implementing such a bond buying program in coordination with all its member states and their separate sovereign bonds. There are no Euro-zone bonds at this time.
If you've a better name for the coming QEU, see our contest offer below. Here's your chance to be famous.
EU Data Gains Influence As Markets Speculate On Coming "QEU"/ "QEZ"
Thus EU policy is still in flux at the very time when Fed policy is widely viewed as set for the foreseeable future (for reasons we gave in our special report here). That's significant because it means markets now become more sensitive to EU data than US data. The Fed and ECB still dominate the pair's fate, so news continues to influence the pair largely to the extent that it's believed to influence the respective central banks. The ECB should be seen as more sensitive to monthly data than the Fed, making EU top tier reports more important in moving the pair (and other markets) than they've been in the past.
As we saw when new QE plans were on the menu in the US, expect markets to move with the data believed to determine timing and scope of the likely coming "Q.E.U." As we discuss in our special report, the ECB is already moving faster in that direction. Anyone doubting that should note that the traditional German opposition to any such potentially EUR dilutive and inflationary moves has disappeared. The only question now is not when but how much Germany will accept. This alone is a sea-change in EU potential EU policy options. Inflation-phobic Germany now truly sees deflation as at least as big a danger as inflation.
That said, neither the ECB nor Fed appear likely to make further policy changes for the coming months, if not the coming year. As we detailed in our special report here, after QE ended no further tightening moves are anticipated beyond minor, token steps amounting to about 25 bps per year. The ECB will likely give the current steps time to take effect before doing more. That leaves the pair to move with any changes in the respective US and EU benchmark rates and overall risk appetite as reflected in leading Western indexes like the S&P 500, which it generally tracks fairly closely. As noted above, if the pair resumes tracking these indexes it should move higher. If investors think it's time for the EURUSD to play catch-up with those indexes (now that uncertainty about ECB easing of the past month is gone) the rebound could be strong and fast.
Impact of Liquidity Boosting Measures Beyond Banks?
The combination of refi rate cuts and negative deposit rates should help interbank lending and liquidity, for reasons we'll discuss in our full report, written for those seeking more detailed and point-by-point analysis.
It's less clear to us if these steps will actually boost lending to the non-financial corporations, SMEs (small and medium sized enterprises), and households (ex-mortgages). As we've noted in the past:
· --They hurt savers at a time when Europe and its aging populations need to build savings and cut debt
· --A negative deposit rate is unlikely stimulate lending due to lack of demand for loans, as over-indebted companies in Europe's periphery (the intended prime beneficiaries of this policy) are reluctant to add more debt-funded expansion at a time when their weak local and global growth (plus a stubbornly strong EUR) suggest weak demand.
· --Negative deposit rate in Denmark in July 2012 did not boost lending.
· --Coming ECB stress tests discourage banks from lending to all but the most credit-worthy borrowers. So until those tests are over, these steps to encourage lending to smaller entities will have limited affects at best.
We aren't the only skeptics. The German Bundesbank, the Association of Private Banks (German banking industry's lobby group), and Open Europe, a pro-European, pro-reform think tank, and a variety of pundits have all voiced the same concerns.
Unintended Risks, Consequences: Asset Bubbles, Liquidity Traps, And More
This new easing carries risks similar to those prior big new stimulus packages we saw from the Fed and other central banks, particularly those that occurred when markets anticipated more of the same in the future.
Primary among these is new or further inflated asset bubbles, in anything with attractive yields, particularly in riskier GIIPs and emerging markets stocks and bonds, and worse consequences from future crises and contagion threats from these areas.
Even in developed markets like the US, the ongoing debate over valuations ranges between whether markets are fully valued already to wildly overvalued.
There are many other likely risks and unintended consequences that will be felt both within and beyond Europe, some of them very unwelcomed and sure to generate resentment. For example, one nation's stimulus can become another nation's deflation, loss of exports and jobs, asset bubbles, etc.
We'll have more on that in our full report.
Protection And Profit Guidelines
The ECB is likely done with new stimulus for the coming months at least, if not for the year, unless things really get worse (possible). For reasons we detailed in a recent special report, Fed policy is also set for now, barring a major change in conditions. Unless something nasty happens between now and the end of Q2 earnings seasons (the start of summer break/doldrums for financial markets) the chances of that are low.
Guidelines for protection and profit include:
First and foremost, remember that the same conditions that have sustained the risk asset rally for risk currencies, stocks and other risk assets (excluding certain China related risk assets) remain in place. These are:
· All major central banks remain in de-facto easing mode, even if some claim they're finished and even moving to tighten, no one is planning to materially tighten for about a year at least.
· No big scary contagion threats.
That means the trends of the past year remain in place and are assumed to continue until further notice. You will need to choose between some mix positions that ride those trends and cash. You don't fight them and damn well don't try to time a reversal until you have some technical confirmation.
We discuss our specific preferences for different types of investors in our full report.
Your Chance To Be Famous: Name That ECB QE Contest
Here's your chance for fame. We're all going to need a name for the coming ECB QE to distinguish it from that of the Fed, which already owns plain old QE. Here are a few examples to inspire you.
· Simple adaptations: QEU, QEZ, QECB, QEEU, QEER (QE-Europe, easier to say than QEE)
· Others: QEGA (QE German Approved)
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.