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.

Why the DKK is different from the CHF

As soon as traders had digested the CHF turmoil, they began to turn their attention to another currency whose exchange rate is pegged to the euro: the Danish kroner. Many have surmised that Denmark's central bank would not be able to defend the peg once the ECB started its QE programme. Some analysts have even gone so far as to say EURDKK Short would be the "trade of the year 2015". However, the DKK peg is different from the CHF peg for one important reason: The Danish kroner has been part of the European Exchange Rate Mechanism ERM II since January 1999. The CHF peg, on the other hand, was only introduced temporarily in an attempt by the SNB to stop the franc's rapid appreciation relative to the euro, which had been under selling pressure from the 2010 riots in Greece up until Mario Draghi's "whatever it takes" pledge to protect the currency. That made the EURCHF floor a unilateral monetary policy tool.

Athough the standard ERM II fluctuation band is +/- 15%, it was decided that the EURDKK exchange rate must deviate no further than 2.25% from the central rate of 7.46038. Historically, maximum deviations have been closer to 1%.

While it is true that Denmark has not made any efforts to adopt the euro yet, there are no signs of the country leaving the Exchange Rate Mechanism either. ERM II puts the Danish central bank in a more comfortable spot than the SNB because according to the mechanism "intervention at the margin is, in principle, automatic and unlimited", meaning that both the ECB and the national central bank will intervene to prevent the currency from leaving the mutually agreed upon fluctuation band. Given that the EURDKK exchange rate peg was agreed upon bilaterally, it is far more likely that Denmark will be able to defend the currency peg with support from the ECB.

Nevertheless, the country's central bank must obviously intervene in the markets to do so. It has already lowered interest rates twice since 15 January (the benchmark deposit rate is currently -0.5%) and temporarily suspended bond sales until further notice, which is an unconventional way of reducing DKK demand by shutting down a channel through which investors could purchase kroners. The central bank is surely looking into further (and stronger) monetary policy measures just to be ready if hedge funds begin to seriously bet against the EURDKK floor.

Either way, EURDKK is an unlikely candidate for a trade idea at the moment. USDDKK will likely continue to go up, but expressing that view is pretty much the same as going EURUSD short, which is what I would consider to be a more likely candidate for "FX trade of the year 2015".

ECB flew €5.26bn in cash into Greece in 2010 & 2011

The Bank of Greece has finally confirmed the long-time rumour that it received cash shipments from the ECB during the height of the euro crisis in its Chronicle of the Great Crisis (PDF, 10MB, English extract from longer Greek version):

Bank of Greece - ECB Cash Shipments 2010, 2011

As the above table from page 28 of the publication shows, the Bank of Greece received euro note bundles worth a total of €5.26bn during the years 2010 and 2011 when the Greek banking system was on the verge of a collapse. The money was reportedly flown into the country in Hercules C-130 cargo planes owned by the Greek military.

The Greek population was quickly losing faith in their banks at the time, leading to a sudden spike in cash withdrawals that banks would not have been able to handle without the extra cash from other European countries. Without the secret cash injections there would likely have been a run on Greek banks, followed by the closure of ATMs and branches. It is notable that the money came from the central banks of Austria and Italy and not from larger European economies such as Germany or France. The report does not state why that was the case, however.

The cash shipments led to an increase in euro notes in circulation from about 8% of GDP in 2009 to almost 25% of GDP in June 2012 as the Bank of Greece gradually released the bank notes into the economy. Cash withdrawals peaked in 2012 right before the parliamentary elections on June 17 when savers demanded almost €3.5bn in cash from their banks.

As this story demonstrates, one can only wonder what is secretly going on behind closed doors in politics and central banking.

Equities at all-time highs, EUR down for the week

The new normal of low volatility, low trading volumes and equity indices making new highs continued last week with the S&P 500 ending the trading week at 1,900, the DAX closing just a few points shy of 9,800 and the EuroStoxx 50 back above 3,200 points. The complacency of market participants is worrisome, especially when taking into account that the VIX is rapidly approaching its pre-crisis low of circa 9.5% from late 2006. Although previous periods of low volatility have sometimes lasted for two to three years, such as in 2005 and 2006, and the present low vol phase began "only" in 2013, we are now at a point where levels are so low that investors should ask themselves where this is going. Again, a look back tells us that the last time implied vol from equity options was this low the volatility spike and subsequent crash of equities were not far away.

VIX 23/05/2014

This time may well be different, but not in a good way. Central banks all over the world are still pushing their otherwise stalling economies forward, and some, such as the BoJ and the ECB, are even expected to ramp up their supportive efforts. About everybody expects the ECB to cut interest rates and perhaps even introduce a negative deposit rate on June 5. It seems that CBs are still desperately trying to force money into riskier assets, such as equities or the bonds of southern European countries. Therefore, the equity rally is likely not quite over yet. However, the air is getting thinner with each new all-time high. The downside risk has become far greater than the upside potential, in my opinion. Low volatility levels are admittedly not useful for timing the market on a day-to-day basis, but they are a first sign of a stagnating rally. Cautious investors will begin to realize their gains and, if so desired, use a portion of the receipts to purchase ATM call options, which would retain their ability to participate in new highs but significantly reduce their capital at risk. Alternatively, you can always hedge your portfolio using relatively cheap out-of-the-money puts, of course.

Turning now to forex: EURUSD trended further down, as anticipated on May 14. The $1.367 support was effectively broken through on Thursday and the single currency fell further to $1.3629 on Friday. Mario Draghi is apparently still a dominating force when it comes to the dark art of verbal interventions. The EUR will most likely approach $1.36 next week, and from there it could then quickly drop to $1.35 as there are no strong supports in between. A lot will depend on how Germany votes in the European election this Sunday and on any news or rumours that might come out of the ECB or Bundesbank prior to the June 5 meeting of the governing council. This year's ECB Forum on Central Banking, which is held in Portugal from today through Tuesday, is one such event that might produce market-moving remarks from the participants. In the absence of any surprising statements, I prefer EUR short positions at the moment. In any case, expect FX volatility to increase during the upcoming week (before implied vol will no doubt fall back to 5%). Enjoy the ride while it lasts.

EURUSD at key $1.37 support level

Wednesday turned out to have been yet another boring day for EURUSD in a way too long succession of uneventful trading days. After last week's price action which sent the single currency roughly 2.5 big figs lower versus the US dollar, and which must surely have left traders squeal with glee in view of a cautious volatility comeback, EURUSD went pretty much back into sleep during European trading hours today.

EURUSD Tick Chart 14/05/2014

With 1m implied vol still not much higher than 5%, intraday price ranges remain relatively unfit for momentum trading for the time being.

EURUSD 1M Implied Vol 14/05/2014

However, investors looking a tad further ahead may see a trend emerging: Downward pressure on the EUR, which started with Draghi's comments on Thursday, increased with yesterday's dismal German ZEW release as well as press reports that the German Bundesbank may finally be at one with the ECB regarding the possibility of rate cuts in June. Comments by Buba President Weidmann suggest that Germany's central bank may support ECB action "if needed", but naturally Weidmann also said the CBs were waiting for additional economic data releases before arriving at any conclusions.

BBG Econ 13/05/2014

Today the EUR made a few attempts to break through the $1.37 support level. EURUSD has already left its uptrend from February and it may drop below the longer-term trend line originating from a July 2012 low shortly. This more important trend coincides closely with the aforementioned $1.37 support level, making further down moves to $1.367 likely in case of a sustained break-out. MACD is also still constructive for such a scenario, but intraday vol may well deteriorate again in the absence of more CB news or data surprises.

Also, as said earlier this week, keep in mind that the closer we get to June the higher the risk of sudden EURUSD up ticks due to policy surprises if the euro continues to steadily devalue versus the major CCYs in the meantime, as the ECB might then no longer have any pressing need to actually follow through on Draghi's announcement. But with FX volatility this low traders are perhaps likely to completely fall asleep anyway, so why care at all? #BuyVol