Euro depreciation continues after Draghi speech

As I wrote only two days ago, I was waiting for the EURUSD exchange rate to hit $1.0765 and $1.06 before closing my short positions. I would not have thought that both of these take profit limits would be hit within a mere two days. So as a follow-up to Monday's post let's take another look at the monthly EURUSD chart.

EURUSD Monthly Chart 11/03/2015

EURUSD is currently trading at $1.0583, which means that all of my short positions have now been closed. Considering that the exchange rate is at a point where two trend lines -- originating from the year 2008 and 2000 respectively -- cross each other, I'm going to wait and see where it will go from here before opening new positions. As of now, I'm biased towards going long given that the euro appears oversold on a short-term horizon. A move towards $1.2 would not be unusual after such sharp declines, although both economic fundamentals and central bank policies clearly speak against such a level right now. Perhaps it is more likely that we will see $1.1 in April or May before falling back towards parity by the end of 2015.

Today's extended drop in the relative value of the euro was ignited by Mario Draghi reiterating at the 16th "The ECB and its Watchers" conference in Frankfurt the ECB's commitment to reach its long-term inflation goal and to bring the central bank's balance sheet back to $3 trillion through 2016. The key statement:

Our decision in September to make use of asset purchases had significant effects. But still, when we announced the purchase of asset-backed securities (ABSs) and covered bonds, there were some in the market place who doubted our commitment and the effectiveness of our monetary policy. They thought we might be hampered either by there being a limited availability of assets that we could purchase in the market or by legal or political obstacles to our ability to expand the range of assets, should it become necessary. If we were so constrained, that would affect our credibility because our ability to anchor expectations relies in part on the fact that we are free to set the appropriate monetary stance.

In this context, the decisions we took in January to expand the range of our asset purchases must have assuaged those concerns. We can deploy – and we are deploying – monetary policy in a way that can – and will – stabilise inflation in line with our objective.

The yields of European countries' government bonds have fallen further since the ECB started its asset purchase programme on Monday. For instance, Italy's 10-year bond yield is now at a record low 1.17% after having fallen below 1.25% yesterday. The yield of German 10yr government bonds is just 0.205% as of this writing (German government bonds with shorter maturities have offered negative yields since the beginning of the year and have since fallen even further into negative territory).

Italian 10yr generic bond yield 11/03/2015

As long as market participants believe that the ECB will be able to achieve its monetary policy goals, there is no apparent reason why the euro should appreciate significantly in 2015 and 2016. My medium-term EUR bias remains firmly short.

Only the Federal Reserve would have the fire power to steer the EURUSD exchange rate in an upward direction, but that is not going to happen unless the United States begin to see the strong US dollar as a valid threat to the nation's economic recovery. That has not been the case so far, despite a few comments from US officials about the euro being artificially undervalued as a means to support European exports. One can only hope that the Federal Reserve will not deviate from its plan to raise interest rates in 2015, because anything else would likely mean an engagement in a full-blown global currency war with unknown consequences.

ECB starts QE programme

The European Central Bank (ECB) started its 1.1 trillion euro QE programme today at 9:25am Frankfurt time by purchasing German and Italian government bonds. While bond yields expectedly fell further, the euro remained almost unchanged.

The EURUSD exchange rate is trading at $1.0852 as of this writing -- having fallen sharply below $1.10 after Mario Draghi's press conference on Thursday last week.

EURUSD Monthly 15-Year Chart 2015-03-09

The euro remains a sell versus the US dollar. From a technical point of view, the next support level is the September 2003 low at $1.0765. A more significant support should be the crossing of the upward and downward sloping trend lines in the $1.057-1.060 area. The geopolitical and economic situations in and around Europe are not supporting the single currency, either. Greece remains a bottomless pit that European politicians continue to throw money into. Greece's list of proposed measures to counter its dire state was rejected by the country's creditors -- perhaps understandably so considering that the list contained such unconventional measures as "hiring non-professional tax collectors, such as tourists". The Russia/Ukraine conflict weighs on investor sentiment, too.

Taking all this into account, I still believe we will see parity by the end of this year, but a short-term upward correction becomes ever more likely. Euro bulls should perhaps wait until one of the above-mentioned support levels has been reached before adding euro long positions, because the trend is still very much intact. On the other hand, I would be very careful with entering into new EURUSD short positions at current levels. Personally, I choose to keep my existing short positions with a 50% take profit at $1.0765 and another 50% take profit at $1.06. If the exchange rate indeed turns around before reaching those levels, I'm prepared to add to my short positions once we get back into the $1.11-12 region.

Macro factors that drove the markets in January

With the first month of the year behind I thought it would be interesting to take a quick look at three major macro themes in the markets at the moment:

Central bank actions -- January 2015 was a month that was dominated by central bank policy actions, most importantly by the ECB which announced a substantial €1,000bn quantitative easing programme on 22 January. However, ECB QE was foreshadowed by the SNB's 15 January decision to abandon the CHF cap, which caused extreme volatility in the foreign exchange market. The SNB apparently did not think it would be able to defend the EURCHF floor once the ECB would begin pumping euros into the economy. The ECB announcement was followed by Denmark's central bank to cut interest rates further into negative territory twice within two weeks. This was to be expected given that the DKK is also pegged to the EUR. Additional central bank actions were seen in Canada and Russia. Central banks were the predominant influence on the markets in 2014 and that is unlikely to change in 2015.

EURUSD January 2015 Chart

Increase in volatility -- Market participants had various negative macro drivers to worry about in January, most notably the drop in commodities prices, political uncertainties and (still) the state of the world economies. Implied volatility in equities, as measured by the VIX index, increased accordingly. The VIX shows first signs of an upward trend that may have started in the fourth quarter of 2014. The expected tightening of Fed monetary policy is certainly one factor behind the increase in volatility, but political frictions with Russia and the recent elections in Greece also weigh on investors' sentiment. Risk-off was a definite theme of January 2015. It also shows in the price of gold and capital flows into other safe haven assets.

01/02/2015 VIX Index Daily Chart

Divergent performance in equities -- However, the performance of national equity indices was more idiosyncratic, as demonstrated by the chart below. While the US stock market struggled somewhat in January, both the DAX and the EuroStoxx50 posted significant gains. Market participants begin to see the strong US dollar as a problem for US exports. In addition, the low price of oil hurts America's oil industry (US oil production is almost at an all-time high), although it certainly lifts a burden off consumers' wallets. As can be seen, European equities were helped particularly by the announcement of ECB QE on 22 January: The DAX has since established a plateau above 10,500 points while the SX5E has stayed above 3,300 points. The Athens Stock Exchange, on the other hand, gave up all of its gains in the last week of January in anticipation of and reaction to Syriza's election victory, which is a major source of uncertainty for the country's economy and the euro zone as a whole. The ASE ended the month at a low of 721.93.

January 2015 Stock Indices Performance Chart

ECB QE + Alexis Tsipras = EUR short

Mario Draghi surprised markets on Thursday by announcing that European national central banks would purchase €60bn worth of assets per month at least through September 2016, bringing the total amount above €1,000bn. Sidenote: On Wednesday, a number of €50bn had been leaked to the press ("sources") -- Draghi is indeed one crafty Italian who knows all about expectations and how to control them. Consequently, the euro fell sharply after the real number came out. The Friday closing price relative to the US dollar was just above the $1.12 support level; intraday lows were below $1.115.

Combine ECB QE with negative interest rates and a diverging Fed monetary policy, and you can only see one way for the EURUSD exchange rate to go: Further down. Last Sunday's target of $1.12 was admittedly reached faster than expected (after all, Draghi had not done his magic yet). So what is a likely next stop? The long-term chart dating back to the year 2000 tells us that there are no significant support levels between $1.1 and parity. After today's news of Alexis Tsipras emerging as the election winner in Greece, the EUR is already at $1.113 in early Asian trading. Taking into account the leftist politician's proclamation that the troika was finally "over", Greece once again spells trouble for Europe.

Conclusion: Stay EURUSD short with a take profit at $1.1 and a tight trailing stop-loss order (max 100 pips, say). If you are not positioned yet, wait out for a less oversold point of entry. Watch EURUSD futures net positioning and sell EURUSD rallies. After a pull-back, which can well extend towards $1.2, EURUSD will most likely resume its downtrend back to $1.1 and beyond.

EURUSD temporarily below $1.15 ahead of ECB

EURUSD Monthly 2015-01-16The EUR ended this year's second full trading week at $1.1567, after having briefly fallen below $1.15 on Friday.

The euro's depreciation had accelerated following the Swiss National Bank's surprise decision to abandon its cap on the value of the CHF relative to the EUR. Market participants have interpreted the SNB's move as further evidence that Mario Draghi will likely announce an ECB QE programme on Thursday. According to press reports, Draghi has already proposed a concrete QE plan to Angela Merkel and her finance minister Wolfgang Schäuble to ease German worries about a collectivisation of European countries' government debt.

But whether the ECB will start QE is not the only open question. The size of any such QE programme is another unknown variable that could ultimately take currency traders by surprise: The ECB said it was going to expand its balance sheet to €3 trillion. Its assets currently stand at roughly €2.17 trillion, which means that the ECB will have to purchase up to €830bn in government debt. Rumour has it, however, that the European national central banks might only flood the markets with €500bn as a first step and that the remainder or even another €500bn worth of assets will be purchased as part of a second QE programme if necessary. As said, those are only rumours at this point, but they are not far-fetched considering that the German Bundesbank remains very sceptical about asset purchases and may thus feel more comfortable with a smaller QE programme.

At least the above chart tells a clear story: The EURUSD exchange rate is pretty much stuck in one-way traffic at the moment. Unless the ECB disappoints next week, the next significant stop will be near $1.12. Despite extreme EUR short positioning in the market, the EUR is not all that much oversold versus the USD from a technical point of view, yet. Stay EUR short or wait for a turnaround signal, but keep up to date on any news about ECB easing measures as they will likely cause some volatility in the run-up to Mario Draghi's press conference on Thursday; a smaller-than-expected QE programme will squeeze EUR shorts.