Investment Conclusions: Short EUR/USD (FXE); Short France (EWQ)
At today’s meeting, as we suspected, ECB President Draghi didn’t make a big policy splash (he left rates unchanged and maintained the asset purchase program target (currently €60B/month until December 2017). However, we continue to see that the main problem with the ECB (Draghi's Eurocrat Economists) right now is that they have the wrong forecasts for BOTH growth and inflation.
In our view, Draghi and the ECB will have to stare reality in the face (lower and slower for inflation and growth across the Eurozone) and we suspect Draghi will have to pivot dovish, rhetorically at the least - a reality the market has failed to appreciate or price. [Currently the market is calling for a QE taper at the next ECB meeting on October 26th]
Mixed ECB Policy Messaging – Draghi vs Hedgeye from Today’s Commentary:
- Draghi – “Net asset purchases to run until end of Dec 2017, or beyond, if needed, until we see a sustained adjustment in inflation”… but…“Underlying inflation have ticked up slightly in recent months but, overall, remain at subdued levels… and “There’s broad dissatisfaction among the ECB council at the pace of inflation.” Hedgeye - We see no path for Eurozone CPI getting to the ECB target of 2.0%; to the contrary we see Eurozone inflation falling below 1.0% within the next 6 months.
- Draghi – “The exchange rate is not a policy target, but it is very important for growth and inflation, and inflation has been revised downward based on the exchange rate.” Hedgeye - how are you going to drive the Euro lower and inflation and growth higher if you taper the size and scope of QE in the Fall?
So, and contrary to consensus, come this Fall we believe Draghi’s hand will be forced to:
A) Extend the duration of his QE program to will growth and inflation higher, and/or
B) Increase the rate of asset purchases to drive inflation and growth higher and the euro lower
But what will Draghi do? Today he said that “probably the bulk of these [policy] decision will be taken in October [26]”
Hedgeye’s Growth and Inflation Outlook:
Today Eurozone Q2 GDP was revised from +2.2% to +2.3% Y/Y for the “final” number, and accelerated from 1.9% in Q1, but our proprietary GIP (growth, inflation, policy) model signals a QUAD 4 setup (growth slowing as inflation decelerates) for the Eurozone in the back half this year.
For reference, the ECB Staff projections for GDP were updated to: 2.2% in 2017 [1.9% in June], 1.8% in 2018 [1.8%], 1.7% in 2019 [1.7 %]
And while the August Eurozone CPI estimate came in at 1.50% Y/Y vs 1.30% prior and expectations of 1.40%, we expect a combination of weaker than expected growth alongside a stronger euro will dampen inflation, far from the 2.0% target. We’re in line with the ECB’s 2017 estimate at 1.5% Y/Y.
For reference, the ECB Staff projections for CPI were updated to: 1.5% in 2017 [1.5% in June], 1.2% in 2018 [1.3%], 1.5% in 2019 [1.6%].
EUR/USD Quantitative Set-up:
The EUR/USD has squeezed right back to the top-end of the Hedgeye immediate term TRADE and intermediate term TREND duration levels.
We believe this can be accounted for on two fronts:
- Fed policy has been more dovish than the ECB’s (and we got the worst U.S. jobless claims number in months)
- The market is (mis)pricing in that the ECB tapers in October.
We advise to trade based on the daily refresh of our risk ranges.
For more detail on our contrarian call on European equities and the Euro see our #EuropeSlowing? theme in our Q3 Macro Themes call (a replay of our 6/30 call for subscribers can be found HERE).
