Market Update: Red Tie, Yellow Tie, Red Tie, Yellow Tie

All eyes will be on the ECB meeting tomorrow afternoon which offers analysts, traders and interested observers the penultimate chance to guess the colour of Mario Draghi’s tie. Popular conspiracy says that this determines what the ECB’s stance on monetary policy will be. (You’ll have to give us some artistic license with the colours in the headline above!)

Undoubtedly it’s set to be a meeting of the ages as a confluence of economic concerns, political issues and changing of the (Presidential) guard all come together for a meeting which may well determine the region’s monetary policy and forward guidance for the next months and even years to come. 

With the powerhouse German economy now in virtual recession and headwinds from trade wars and Brexit becoming stronger, the market expects Draghi to deliver on his July meeting ‘promise’ by announcing a large stimulus package. The uncertainty is not whether the ECB will announce new measures but how much it will deliver among the myriad of possible easing initiatives.

Most analysts believe the package will come in several parts, to include a rate cut, strengthened forward guidance, a relaunch of net asset purchases (QE) and some degree of rate tiering. This last policy would be to mitigate the negative impact to bank profitability.

The cut in the deposit rate would be the first since 2016 and take it further into negative territory. Markets are currently split on whether the ECB will move by 10 basis points (55%chance) or 20 basis points (45%). A new asset purchase programme is also contentious, not least because the ECB is getting close to the limit of buying on some government bond issues.

With the growth and inflation outlook expected to take a beating in the new forecasts, it seems any change in direction by the ECB would seriously dent the bank’s credibility and risk destabilising markets. The gap between its own target and inflation expectations also seriously warrants a significanteasing package. Yet the ECB’s hawks and even some centrists have been vocal in their opposition of more QE and its negative effects. 

Expect heightened volatility around the announcements at 11.45 GMT and subsequent press conference at 1230 GMT. The euro is likely more sensitive to a larger than expected rate cut than a larger QE programme. Only a 20 basis point cut and more would hurt the single currency as a 10 basis point move is fully priced. 

Generally, markets have moved away form safe havens this week on news that China will take further action to ease the pressures of the trade dispute on its economy. Whether this is a real game changer seems highly unlikely so we would expect the Chinese approach to trade talks to remain the same. This should mean the trade-weighted dollar moves higher and emerging market currencies feel the heat once more. 

The short squeeze in sterling has continued although narrow ranges and risk premia have softened recently. Most pundits now think a snap election will be called next week and be held after 31 October, implying a deadline extension into next year. Options markets agree and indicate late November stress which is when the elections are likely to take place. Enjoy the calm for now but expect pressure on GBP to return once the election is called. 

Or tune in to the ECB conference and #draghitieguesses. (nb. Red tie at night, bullish delight. Cool blue in the morning, easing is stalling)