Dilemma for ECB this week

The tone was positive into the close last week with solid gains across the board in the equity

space. The GBPUSD fell back from that highlighted 1.30 level with the dollar generally

gaining on the week. Those gains were not only highlighted by that relapse in the GBPUSD,

closing back below 1.29 (at 1.2872), but also by the EURUSD falling back towards 1.1350 as

the USDJPY edged back up towards the 110 handle.

Looking at the moves (or lack of them) overnight, the markets are very quiet in early trade

this morning. That’s largely due to the US being closed today in memory of Martin Luther

King which is having a dampening impact on activity in general and in the FX space in

particular. However, there’s a lot that could unfold to change that before the week is out.

So, as I look out over a very frost laden landscape this morning, I am reminded that it’s now

that time of the year when the great and the good will gather this week for the world

economic forum in Davos, Switzerland. On this occasion there will be notable absentees

with the US President and UK Prime Minister not in attendance. Both have more serious

domestic issues to attend to of course- plan B for both of them I think!

The other protagonist who might miss this week’s winter jolly up is the ECB president, Mario

Draghi who is due to preside over the first governing council meeting of 2019, taking place

in Frankfurt on Thursday. Whilst the ECB are fully expected to leave all aspects of current

policy unchanged this week, it’s what forward guidance they deliver on Thursday that will

surely attract much greater attention from the markets.

There can be little doubt that Eurozone growth faltered in the final quarter of 2018. A fact

that was well demonstrated in December by the seasonally adjusted downward revision to

German GDP for 2018 as a whole, to 1.5% from a previous estimate of 2.2%. Data elsewhere

from the Eurozone most lately certainly endorses that and so all this comes at a bad time for

the ECB who have only just ended their bond purchase program.

So given that, the last thing that Draghi and the ECB need now is for the Eurozone recovery

to falter further. The possibility that this may now happen is surely creating a significant

dilemma for them. The need to highlight this issue later this week is surely countered by the

potential to sound more alarm bells by actually doing so.

The fact that EU rates are still negative does not put the ECB in a good place if they do need

to counter another significant downturn. So, there is an argument, just as with the Fed last

year, for the ECB to move rapidly to a more neutral stance in order to be better placed

should that happen. The problem for Draghi and his colleagues is whether or not such policy

action merely increases the chances of what they seek to avoid actually happening.

Hence, it could be interesting to see how the ECB boss plays this on Thursday. I am pretty

sure the phrase; ‘Temporary or Seasonal factors’ will come into play at some point in

Draghi’s press debrief narrative.

Meanwhile, the early January bounce for the EURUSD to above 1.1550 has fallen on its backside once again as defined by the close last Friday at 1.1363 being below all of its important short/medium term moving averages.

So, despite all the ‘professional’ calls for the EURUSD to rise this year it’s not so far giving a

very good impression of doing that. It could even be that Q1 is actually a period when we

see an opposite move play out. Let’s not forget that Q1 last year saw the dollar fall under

the sword only to rebound sharply as the year unfolded.

So, if the EURUSD is to end this year higher, then perhaps it would be consistent if 2019 saw

a similar dynamic play out? The other component in all this; is of course this side of the

channel and where that all ends up. The potential impact of Brexit on the EURUSD should

not be underestimated, or seemingly overlooked as some pundits appear to have done,

remembering that Q1 doesn’t end until after 29th March!