There's a Euro story, and there's a Dollar story ..... but most of all there's a Euro / Dollar story .....

Friday 27th October 2017


There's a Euro story, and there's a Dollar story ..... but most of all there's a Euro / Dollar story .....

ref :- General

One of the dangers when writing pieces about markets is that however valid one's ruminations may or may not be, things can change so quickly as to make them instantaneously obsolete. Such is the case today as in Madrid the Spanish parliament votes on the imposition of direct rule over Catalonia (very likely), and Catalan President Carles Puigdemont and the parliament in Barcelona decide whether to stick or twist. This guy is really in a difficult place, facing an intransigent Madrid and an absence of support from anywhere outside of Catalonia on the one side, and a hard-core of Catalan secessionists demanding nothing short of full independence on the other.

If the decision in Madrid looks easy to predict, nobody can be sure quite which way the Catalans will go, though if one thing is certain it's that not everybody can be happy. Spanish stocks may have been underperforming, but other markets have largely been able to shrug off the issue so far. Whether they'll carry on doing so if protest turns into civil disobedience for example, and the EU's biggest internal constitutional crisis continues to escalate, must be open to doubt. The odds are that you'll know how things have gone today before you read this, but whether that makes the future any clearer for anybody is another matter.

Anyway, with that rather large proviso in mind, there are two big issues merging into one today. The first is a Euro-bearish story, and of course is based on the ECB's plans for their Quantitative Easing (QE) programme for 2018. If they only read about the bare facts of the matter, some might wonder just why the Euro has taken such a tumble since yesterday lunchtime  --  after all, the decision to halve the current rate of bond purchases to €30 per month was widely predicted, as was it's time-frame of the nine months Jan - Sept 2018.

The meat of the matter, as so often, was in ECB boss Mario Draghi's statement. If the markets expected Mr Draghi to be cautious, the depth of his caution was a surprise. The emphasis on how ready the ECB are to extend QE beyond September , even to increase it if necessary , made this a "doveish" announcement. Since Mr Draghi was happy to acknowledge the Eurozone's strong economic performance, one can assume that his main worry must be continuing low inflation. Just in case anyone was still in doubt about the ECB maintaining its accommodative bent, Mr Draghi told us that the taps are unlikely to be turned off in one hit even after September. And if anyone was bold enough to start even considering a reduction in the ECB's balance sheet  --  a reversal of QE  --  Mr Draghi had words to say on that too : the ECB will continue to re-invest the proceeds of maturing bonds on their book by purchasing bonds to replace them. In other words, "No Quantitative Tightening Here !"

We had to smile at Mr Draghi's use of the word "downsize" instead of "taper", a word with hawkish connotations and distinctly unpleasant memories for market investors  --  your vocabulary really does matter when you're a central banker. It's all right Mr Draghi, we get your point : rate rises, which you've said can't happen until "well past" the end of QE, are postponed to Q1 2019 at the earliest, and you're going to withdraw stimulus very gently indeed. We understand that there were 4 dissenters on the ECB council (German and Dutch ?) wanting a firm end-date for QE, but if Bundesbank president Jens Weidmann was one of them, he's in the running for your job when you go in 2019 and is unlikely to ruffle too many feathers.

If that's why the Euro's weak, why's the Dollar strong ?

Mostly, this morning's moves are about the plan for tax cuts and how yesterday's adoption of a budget resolution on the issue by the House is a step on the way to getting the plans into law. Not that there aren't considerable obstacles sill to be overcome  --  not upsetting members of your own Republican party so much that any more than two of your Senators vote against it, for one thing. Also, there's the small matter of actually letting those about to vote on the bill know exactly what's in it. Still, any perceived increase in its chances of success are seen as bullish for stocks and the Dollar, and bearish for bond prices (which means yields higher, of course).

It's crucial to separate the political from the economic here, and the short-term from the longer-term. There are legitimate concerns that Mr Trump's tax plans over time won't in fact benefit the middle-class as he claims, but instead be a boon to the wealthy and bad news for the needy. Whether that viewpoint is born from a political stance or not, the fact is that the markets will see the tax plans as at least a short-term boost for consumers and the economy (which of course would maintain the upward pressure on rates and therefore on the Dollar too). Equally, slashing corporation tax from 35% to 20% will plainly be of benefit to companies and their share price, even if the longer-term outlook is compromised by the recent corporate preference to use the extra cash for share buyback schemes etc rather than investment.

One thing that most are agreed on is that should the plans get through in anything like the form that we think the administration is intending, it would be unwise to have much faith in their claim that budget-wise the measures would be revenue-neutral, even in the longer-term. The idea that the loss of government revenue from lower rates of tax will be more than made up for by a larger take from a larger economy is not supported by the evidence, attractive theory though it sounds. We'd have to expect an expanding deficit (if the hawks allow the plans to go through) , which of course means higher bond yields and lower prices  --  itself Dollar-bullish. We'll wait to see if the recent uptick in yields proves to be the beginning of the end of the great 35-year bull market in bonds that so many "bond gurus" have been calling for  --  they've been shouting about it for a while now but perhaps they've got to be right sooner or later.

We should also briefly consider this morning the latest update on the "Chairman of the Fed" Stakes, which has seen Kevin Warsh dropping right out of contention and Janet Yellen falling back too. Jerome Powell still leads, but John Taylor is said to be gaining ground and has received overnight backing from "influential" commentators. As we know, Mr Taylor is considered the most hawkish of those still in the race so any perception that his chances are on the up is Dollar-friendly.

So there you have it ..... a generally weak Euro, and a generally strong Dollar. All of which makes the Euro - v - Dollar rate the standout pairing of the day. EUR / USD is trading at $1.1610, down over 2 cents since just before the ECB announcement yesterday. That's a big move .... but is it the start of a new trend ?

Have a nice weekend.