Investment Recommendations: short EUR/USD (FXE) and Eurozone equities (EZU); Long GBP/USD (FXB)
As is customary, Jackson Hole affords central bankers the stage to make a “splash”, and the ECB’s Mario Draghi did just that, on Friday (8/22) solidifying the title of “über” dove, even beyond our expectations.
What are the tea leaves indicating? Accelerated QE expectations! Draghi said “we stand ready to adjust our policy stance further.” An acceleration in the “adjustment” towards QE is what we foresee out of the meeting and given the backdrop of deteriorating Eurozone fundamentals and in our estimation little prospect for medium term inflections from the TLTROs and QE-lite (ABS buying) programs. What initial indicators may begin to turn the tide?
- We expect in aggregate that Eurozone Confidence figures for August (out this Thursday) to show sequential decline
- We foresee the Bank to be unable to arrest the decline in inflation. CPI stands at 0.4% and the preliminary August reading (out this Friday) should show further contraction, likely by 10bps. Draghi is both way off base from the 2.0% LT target and showing a material inflection over the medium term
- Sticky and high unemployment currently at 11.5% (the July reading comes out this Friday) should persist over the medium term
- We expect the ECB’s staff projections for growth and inflation to be revise down in its next meeting on September 4th
Taken together, we’re not calling for the announcement of QE next month, however we do think QE expectations will heighten as fundamentals continue to go against the Bank’s price stability mandate.
What cards has Draghi already seen that may influence his use of policy “tools”?
- Q2 GDP showed the EU region stalling to 0.0% sequentially and +0.7% Y/Y (For more see: Ouch! Eurozone, Germany and France GDP Fall in Q2)
- Recent PMI data confirms a similar “slowing” picture:
Eurozone Manufacturing PMI 50.8 AUG Prelim. (51.3 est.) vs. 51.8 prior
Eurozone Services PMI 53.5 AUG Prelim. (53.7 est.) vs. 54.2 prior
Eurozone Composite PMI 52.8 AUG Prelim. (53.8 est.) vs. 53.8 prior
- German data remains lousy. Today’s release of the German IFO Business survey showed a material slide, and is in-line with German Q2 GDP that slid to negative (for the first time in two years at -0.2% Q/Q); as well as weakness from Factory Orders, Industrial Production, and Economic expectations seen over recent weeks. For more see: Germany Under Pressure: ZEW Tanks
Germany IFO Business Climate 106.3 AUG (107.0 est.) vs. 108.0 prior
Germany IFO Current Assessment 111.1 AUG (112.0 est.) vs. 112.9 prior
Germany IFO Expectations 101.7 AUG (102.1 est.) vs. 103.4 prior
- Bond yields are front-running the slowdown in economic growth, with the German 10YR bund yield trading below 1%!
We’re sticking with the Hedgeye investment playbook we had going into the meeting, which includes:
-- Short EUR/USD (FXE). Net short position in the EUR/USD (CFTC futures + options) hits a big year-to-date high of -142,758 contracts.
--Short European equities (EZU) which, despite the recent bounce, remain below our TREND levels of resistance. If the equities overcome their TREND levels, we’ll change our positioning:
Equity TREND lines remain broken:
Europe’s Stoxx50 = 3,158
Germany’s DAX = 9,643
Italy’s MIB = 21,311
France’s CAC = 4,364
-- Long GBP/USD (FXB) - BOE Minutes released last week showed for the first time in more than three years that there were 2 votes to increase interest rates (by 25bps). Taken together with the dovish policy from the Fed’s Yellen and ECB’s Draghi, and relatively stronger economic data from the UK, we expect the GBP/USD to appreciate in value.