EUR/USD: Will Draghi Surprise Again Tomorrow?

 | Dec 02, 2015 07:20AM ET


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EUR/USD: Eurozone Inflation Below Expectations

  • Consumer prices in the Eurozone increased by 0.1% yoy in November, the same pace as in October, and by less than the market consensus of 0.2%
  • The main factor that capped price increases was a fall in energy costs, which were 7.3% lower this month than a year ago. Unprocessed food was 2.6% more expensive. Without these two volatile elements, the inflation measure that the European Central Bank calls core inflation, was 0.9% in November, down from an upwardly revised 1.0% in October.
  • Industrial producer prices in the Eurozone were down by 3.1% yoy in October compared to the previous month.
  • The ECB's Governing Council will meet on Thursday and is widely expected to bolster the quantitative easing programme. Considering the expected cut in interest rates, a cut of between 10-15 bp is priced in for the deposit rate, with the market leaning a little more toward a larger cut. There is, however, an impression, and also a track record, of doing more to surprise and so maintain an aura of being ahead of the market, so a larger cut is possible. This is especially true if a tiered system of cuts is engineered. So while a 15 bp cut in the depo rate would drop it down to -0.35%, there has been talk that a tiered system may see a more conventional cut of 10-15 bps, with an even bigger cut for some measure of excess deposits, down as far as a -0.50% rate. There are, however, issues with a tiered rate system, both operationally and potentially awkward politically. Regarding expanding the QE program, this option is less in favor by at least some members of the ECB Board vs. another cut in interest rates. The absolute minimum expected regarding the QE program is for an extension from its current end date of September 2016.
  • We should know that Draghi’s track record, specifically his inclination to surprise, must by now have been incorporated into the market’s perception. Consequently, we think that investors are going to the meeting “well-prepared” even allowing for the possibility of some surprise. A bold ECB stimulus package may drive the EUR/USD below this-year minimum at 1.0457. A deeper cut in the deposit rate would mostly trigger a short-term psychological effect on the EUR/USD, pressuring it towards the 1.03-1.04 area.
  • On the other hand, the Fed is widely expected to begin tightening monetary policy at its next meeting on December 15-16.
  • Fed Governor Lael Brainard said that the Federal Reserve should go slow in raising rates, adding that there may be limits to the Fed's ability to tighten monetary policy while other central banks keep it loose. She added that weak growth abroad has pushed up the value of the USD, pushing down on inflation and the level of interest rates that the economy can withstand while still generating jobs and growth.
  • Chicago Federal Reserve President Charles Evans said the Federal Reserve should use the communication tools at its disposal at its December meeting to spell out a gradual pace of rate increases.
  • In our opinion, the EUR/USD recovery is likely after the December FOMC meeting – a hike is already priced in and the statement will be probably relatively dovish as the main mission for Fed policymakers is to convince markets that rate hiking path will be gradual.
  • Watch today’s US ADP employment data (13:15 GMT) that may change expectations for US non-farm payrolls on Friday.
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