Euro traps Draghi
Investors are bracing for an event heavy day. The highlight will clearly be the European central banks. However, the substantives information on monetary policy strategy path from this meeting is unlikely. We had originally penciled in a comments outlining the path towards normalization. The recent strength in Euro will keep the ECB focused on exchange rates and likely water down any discussion on extension of the Asset Purchase Program. While economic data has improved significantly in the EU, a slight delay to measure the market’s reaction to any Fed actions won’t meaningfully risk a surge in inflation outlook.
Yet, titillating the markets with hints of cutting QE purchases (even buffered with minimal extension) could send EURUSD back above 1.20. We don’t think Draghi will take the risk. There is a case that Draghi is only delaying the inevitable and should start announce an QE extension today to prepare the market for eventual trimming of size. Markets will likely dissect every sentence causing EUR vol to increase, but the longer-term outlook indicates that the ECB need to start tighten policy. The Euro has become less sensitive to short-end yield movements; beneficial yields spread will send EURUSD higher. Europe has enjoyed the benefits of a weaker Euro, judging from the improvement in German industrial production (4.0% from 2.7% y/y) exports will need to adjust to a strong Euro moving forward.
Long SEK Riksbank delay
Elsewhere the Riksbank will keep to the sidelines in their rate decision today. Sweden central banks is likely to prefer to let the ECB to move first on normalization. The Riksbank today will likely copy Draghi trick of balancing acknowledging stronger economic growth without shifting policy strategy. However, as with Euro traders the market sis not fooled by the delay. Sweden’s above trend in growth and inflations indicates that policy needs to tighten. In addition, as with the ECB asset purchase program technicalities could be actually preventing the Riksbank from purchasing more assets. Any suggestion that market liquidity could handle further intervention would be a marginally dovish outcome and negative SEK. However, most logical path for the Riksback are slow and steady removal of emergence measures and strong SEK.
Donald and Democrats deal
Finally, Wall Street is celebrating the removal of the immediate threat of the debt ceiling. However, the real news was Trump working with Democrats with a clear success. In rare bipartisan deal Trump, republicans with democrats extended the U.S. debt limit and provide government funding until Dec. 15th. Should the Republican-led Congress pass the bill, the 3-month deal would prevent an extraordinary default on U.S. government debt, preserve the government funded for the fiscal year starting Oct. 1. This was a massive first step. True it was clipped to a money for victims of Hurricane Harvey but still. The path towards meaningful tax reform just got a little less steep (an potentially other stimulus). As a desk we were early to write off the Trump pro-growth, reflation story, however a shift to the center, highlighted by this 3-month extension, could the start of something real. A unified US government could have profound effects on our market outlook.
