Proceed With Caution - It's The ECB

 |  Includes: FXA, FXB, FXC, FXE, FXF, FXY, NZDS, UDN, UUP
by: Dean Popplewell

By Dean Popplewell

It's not unusual to see European markets steady after a sharp geopolitical gain; a gain that was sometimes confusing once given the "he said, she said details" between Russia and the Ukraine. Investors prudently seem to be adopting a "wait-and-see" approach ahead of key policy announcements today from the BoE and ECB. The forex market in particular has been handcuffed by monetary policy, succumbing to the lack of volume and volatility supported by a "low" rate environment. To experience sustainable volatility within this asset class, the market requires interest rate divergence, a phenomena that is not on the cards for a considerable period of time according to interest rate pricing in the fixed income markets.

Nevertheless, caution is the key word ahead of today's ECB rate decision and press conference. The potential for ECB action has been on the rise ever since Draghi's extra-dovish Jackson Hole speech late last month. The surprising hints has the market undecided on whether the ECB will announce further easing measures - cut rates or introduce QE - to stimulate Europe's already sluggish economic recovery, or wait and access the true impact of the credit programs announced in early summer. No matter what, euro policy makers need to act with authority to gain significant traction from any their initiatives and the ECB, in particular, has a history to potentially disappoint. Due to the current positioning of the market (short EURs) any disappointment by Draghi and company will give way to a rapid short covering rally from the EUR (€1.3145).

Words and no action

The dollar has been gaining ground against the EUR and JPY as the Fed gets closer to raising interest rates, while the ECB and BoJ move towards possible further loosening of their monetary policies. If there is no action from the ECB, then Draghi is likely to re-affirm the ECB's commitment to further "potential action" mostly on the back of downward revisions to their growth and inflation forecasts in his post press conference. It's here that he may provide more details on potential ABS purchases. Any further insight could be viewed that the ECB is not falling short of expectations, and in a roundabout way, vindicate the various position that have been taken. Yet the ECB does have a track record to potentially disappoint and any disappointment could be short lived ahead of tomorrow's highly anticipated NFP release.

BoJ neither disappointed nor supported

Despite expectations of a more upbeat policy statement on Japan's economic resilience from Governor Kuroda, the BoJ stuck to its familiar script and kept their overall assessment unchanged at their monetary policy meeting earlier this morning. The Japanese "economy continues to recover moderately as a trend." The BoJ took no chances and affirmed its assessment of exports, investment, employment, consumption and inflation while lowering its view on housing.

USD/JPY (¥104.90) is little changed and has failed to make any impact towards new yearly highs. It seems that the market would prefer to see what happens both in Europe and with tomorrow's US job numbers before committing to the dollar's next move. The yen of late has come under pressure, not just on the difference in monetary policies, but on expectations that Japan's government pension fund could be embarking on a more aggressive investment plan. This would require a shift to more foreign assets and less of a reliance on domestic bonds. This course of action would see the aggressive selling of yen to raise foreign cash to purchase foreign assets.

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