Investment Conclusion: EUR/USD (FXE) [Bearish TAIL View]
Draghi is going dovish because the data is going dovish. As no great surprise to market consensus, today ECB President Draghi left rates unchanged and cut QE purchases in half to €30 billion per month starting January until September 2018.
However, the key indication that Draghi will leave the dovish door open (read by the market as EUR weakness) came in his ECB prepared remarks:
“If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the Asset Purchase Program (APP) in terms of size and/or duration.”
And…
“The Eurosystem will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary.”
Draghi’s Reality Check:
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 (inflation and growth lower and slower across the Eurozone) and as we suspected, Draghi’s “Dovish Taper” today is a reflection of that – he must have the ability to keep his foot on the QE gas to attempt to wield a weaker EURO and boost inflation!
Our proprietary GIP (growth, inflation, policy) model suggests a QUAD 4 setup for the Eurozone in the remaining two quarters of reported 2017 data, equating to growth slowing and inflation decelerating. As we move into Q1 of next year, the model suggests a quarter in Quad 1 (growth accelerating as inflation decelerates) and in Q2 a move to QUAD 3 (growth slowing as inflation accelerates).
On Growth – we refer you to the chart below: our Q3 & Q4 GDP Eurozone GDP estimates remain below consensus expectations; while we beat consensus in Q1 & Q2 of next year, the results are lower lows off of a Q2 2017 print of 2.3% Y/Y.
On Inflation – 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% (see chart below). As a reminder, in its September ECB Staff Projections report, the ECB forecast inflation at 1.5% in 2017, 1.2% in 2018, and 1.5% in 2019. So even if Draghi meets his own forecasts, he still will not reach his target!
Willing the EURO Lower:
With Draghi leaving the dovish door open, the EUR/USD fell on today’s announcement. Our fundamental long-term view on the Euro remains bearish, and our intermediate-term quantitative (TREND) signal remains neutral, for now. That tells us we should actively risk manage the trading range of the EUR/USD, currently at $1.16-1.18.
As it related to our Real Time Alerts portfolio positioning, on Monday Keith covered FXE, on the US Dollar Index’s gain of +0.7% in the prior week, its 5th weekly gain in the last 6, and oversold levels in FXE.
Our longer term bearish EUR/USD conviction is born out of the belief that Draghi’s longer term growth and inflation forecast are wrong, and therefore he will have two options over the intermediate to longer term:
- Extend the duration of QE (past the September 2018 horizon), and/or
- Increase the pace of QE
Happy Trading!
