Thanks for nothing Draghi and farewell Singapore

Posted on December 4, 2015 1:30 pm by Greg

Good morning in Asia, the day after the ECB let-down.  This is my last day in the Singapore office of  And it’s presentation day for the upper elementary at the Australian International School which I want to attend to see Josh graduate.  So it’s a short day for me, but I wanted to at least send out a few words to let you know I have not gone into hiding after getting the ECB call wrong.

I will be travelling through Australia for the rest of December before heading to Breckenridge, Colorado, USA; our final destination.  As a result my posts will be more sporadic until I set up shop properly in January.

If you were following my AmpGFX reports you might have guessed that I went into the ECB meeting with significant shorts in EUR and GBP against both USD and JPY.  I had also re-established a short AUD position on Wednesday after the trio of weaker data, ongoing weakness in commodity prices and a high level of the AUD trade-weighted index, around its high since July.  So all up I had a lot of risk on my plate.

I was not uncomfortable with the risk since this was an important week and I had a strong view on the ECB and thought it worthwhile going into the meeting with decent exposure.  For those that make a living out of trading or managing money, including myself these days, you might say it was necessary to have positions backing the view.

My comfort level with the positions was helped by the fact that most of my trades were in the money and I expected not to fall much below square one in the worst case scenario.  I guess when you are trading your own capital you can afford to be a little more variable with the risk tolerance, and my capacity to accept a draw-down is larger when trades are in-the-money.  As someone that aspires to manage the capital of others this may be style that needs adjusting, and I am seeking advice from people that have opinions on the best practice in these matters.

That is not to say that I am not affected by seeing large draw-downs. Of course I want to keep what has been put in the tin and I was watching intently last evening as the ECB decision was released and the press conference delivered.  My stop losses were in place and I was ready to respond if I thought that could make a difference.

The market reaction to the ECB event was telling and probably not that surprising.  The large bounce in the EUR reflected a very strong consensus that Draghi was going to lead the ECB council to take a substantial across all fronts further policy easing.  Fundamentally this was likely to significantly reinforce a relatively rapid falling trend in the EUR.

Some may say - if it’s all expected, then there is little further for the market to react.  But in this instance, close to year-end, a lot of risk takers are playing it safe responding less to their view, leaving capacity for them to be drawn in after the fact and belatedly, thus reinforcing a trend.  The full nature of the impact of QE and negative rates is less understood and can take time to develop.  And there are some that come to the consensus view late in the game, don’t have the trade on and feel they have to wait for the event before reacting.  The fact that the EUR was falling in the last minutes ahead of the decision was probably driven by those that were trying to wait for the event but gave up at the last minute and decided to sell.

After the ECB first announced a 10bp cut in the deposit rate from -20bp to -30bp, the EUR bounced relatively sharply.  This was the most expected out-come, and the fact that the EUR bounced on it was the first warning sign that the market was well short and the underlying consensus of traders and investors with exposure in the market was that the ECB was likely to over-deliver.

The cut in rates was the minimum expected, with many, including myself, expecting a deeper cut.  I watched and thought about the market for a bit as we waited for the press conference where further QE measures would be announced.  The EUR was whipping in a relatively volatile fashion indicative of the nerves in the street, but it appeared to be resolving to the upside ahead of the press conference.

At this point I closed all my positions down.  As I said I am not totally immune to seeing the money being whisked out of the tin.  My concern was that the market reaction to an essentially as expected cut in the deposit rate was relatively severe.  My second concern that started to rise from this point was that if Draghi had under-delivered on the rate cut he may under-deliver on the whole package.

In fact it seemed most people in the market were coming to the realization that it was a forlorn hope to expect him to compensate with a bigger than expected QE package.  There were no indications ahead of the meeting that the ECB preferred QE over rate cuts.  In fact the opposite appeared to be true with potential limitations in the amount of assets that it could buy; a bigger rate cut potentially opened the door to more QE, a lesser rate cut may limit the scope for more QE.

Seeing the volatility in the EUR my concern was that it could trigger all range of potential outcomes in other currencies, so I closed all trades down.  I waivered somewhat on the short AUD position, as less policy easing by the ECB might have negative implications for the AUD, and my case for the short position had little connection to the EUR or the ECB.  However, I wanted a clean slate.

Indeed Draghi did under-deliver on all aspects of the policy announcement.  He made a token contribution to the size of the QE through a reinvestment announcement and a token increase to the duration of the program by six months.  In the end, the rate cut that was the minimum expected was the biggest part of the overall additional easing package.  As this became clear EUR rose substantially further.

Draghi was asked during the press conference why didn’t he do more and hadn’t he misled the market by building up expectations of something bigger?  Draghi disagreed that he had misled the market and thought the measures taken were significant and would achieve the ECB’s objective of near 2% inflation within a reasonable timeframe.

Perhaps he is right. He has enhanced the easing policy, rates have been cut, the QE should now be expected to run for longer, over which time they will build the balance sheet higher than previously projected.  Given enough time for reflection and market positioning cleansing the EUR should remain relatively weak, interest rates extremely low and asset prices solid, supporting an economic and financial sector recovery that is under-way.  In some context he has still delivered.

However, the market can still feel that it was significantly wrong-footed by assertions by Draghi only a week or so ago that he would “do what we must to raise inflation as quickly as possible”, and “we will not ignore the fact that inflation has already been low for some time.”  The ECB staff projections in fact downgraded its forecast for inflation somewhat.  They said, “Inflation is expected to rise over the projection horizon, to 1.6% in 2017. The inflation outlook has been revised down slightly, mainly reflecting lower oil prices.”

So low oil prices may be a factor worth looking through, but the outlook is for a more prolonged period of inflation below the near 2% target, playing directly into the risks that Draghi highlighted he wanted to mitigate.

The fact that the ECB has under-delivered at this crucial juncture has undermined confidence more broadly that it will be proactive over the period ahead.  Inevitably there is concern that the German led opposition to extraordinary policies to generate inflation is gaining traction, limiting the scope for further action.

I don’t think this generates an argument for the EUR to rally, but it suggests that the bottom may not be as deep and it could be slower to get there.  I still think the EUR heads below parity in the year ahead, but I am less confident than before, and there is a scenario that has increased in probability, but is still a low one in my view, that the low has been seen.

My intentions are not to jump back into a short EUR position at this time.  Some reasons are personal but some reflect the mood that many will feel.  We are close to the year end, and the market will increasingly be reluctant to take risk.  Policymakers may also like to wrap things up for a while.  Especially those in the southern hemisphere that have summer holidays on their mind.  The RBA routinely take January off from their regular monthly meeting schedule and Governor Glenn Stevens told us all to chill-out a week or so ago.  So we know where his mind is at.  That said there is a finely balanced RBNZ decision next week, more on that below.

This is not the best time to take a short position in EUR that is more fundamentally based, because fundamental traders are taking time off and it may take some time to develop.  However, if the EUR were to rise significantly further to a technical level that should tend to cap it, I may sell again.  And I do have a level in mind.

Personally, of course I have a lot on my plate with the move and will be on the road over coming weeks rather than in an office assessing markets.  A lot of that time will be with family and taking time completely off the markets.  So naturally it is better to keep trading lighter (if I can help it).

Furthermore, we can assume from the rapid and significant rise in the Euro there will have been very few people that made money in the bounce and the vast majority have had some skin taken off.  I doubt this close to year-end, these traders will feel compelled to strap on risk again ahead of the US payrolls report.  While a solid number is the consensus, a weak number would certainly throw another spanner in the works.

The US labour market is the main supporting factor behind the Fed argument to raise rates for the first time on 16 Dec.  I firmly believe the Fed will move ahead with this hike, even on a moderately weaker than expected outcome on Friday.  However, the market is at risk of being further significantly wrong-footed and fall flat on its face if it’s a weak number.

The other aspect of the price action on the ECB decision overnight is that liquidity in the FX market is not as deep as it used to be, and the market is vulnerable to sudden and sharp moves.  I think there has been a significant shift in the market place over the last year or so with less risk taking at banks, less communication across the market on orders, a growing set of smaller traders with deep access to electronic platforms and an overall greater reliance on electronic platforms across all levels of the market.  I have heard it said that there is “phantom liquidity”; it is deep in normal conditions when electronic trading and diverse market activity bring spreads in,  but the liquidity can disappear quickly around key uncertain events when markets can get one-sided and market-makers pull back.

As such, we need to be prepared for odd-angry moves in the market, and this makes me more wary of setting trades into key events like the payrolls report when the market is already gun-shy after the hit from the ECB and approaching year-end.  It feels like the risk is skewed with a fat tail on the weaker USD side, against my fundamental view that the USD should strengthen in coming months.  This further drives my decision to chill-out with a square book for the time being.

If I was inclined to take a position, I mighty turn back to the AUD.  It may be starting to stall after its recent upswing.  It could have jumped more with the stronger EUR on Thursday. The wedge between commodities and the currency has widened out.  Housing market data may be cooling, the government faces a tougher job balancing the fiscal accounts and this will be revealed in the next week or so in the MYEFO.  There are some technical resistance near-by.  After improvement in business conditions, consumer confidence and employment in recent months, these indicators due next week have less scope to over-whelm. The weaker commodity price outcomes, chilled-out RBA as the currency rises, and weaker budget outcome expectations may dampen sentiment surveys.

There is also a full suite of Chinese data, and while expectations are already low, I have little reason to see confidence returning to the commodity sector.   If I were more focused on trading in the next week I might be inclined to get back into a short AUD position.

The New Zealand rate decision next week is an interesting one.  The market has a 40% chance of a rate cut priced in, but the Bloomberg survey has 15 of 17 surveyed analysts calling for a cut of 25bp from 2.75%.

New Zealand is one of those markets that is small enough that it seems there are some in the know more than others. I am not saying the RBNZ leaks, but the locals stay close to the RBNZ and read the tea leaves better.  So you really need to ring around and talk to the right people to figure out the true odds.  However, it has not been my focus this week and I am out of time to start now.

It is not clear to me what the RBNZ should do at this juncture.  The data has in general being showing a pickup in recent months and activity is robust enough to suggest they should not cut.

However, inflation indicators (outside of housing) are very low and they could afford to cut.  Dairy farmers are feeling the pinch from low dairy prices and there is a threat of drought.  This is a risk the RBNZ need to keep in mind, and one they should at least iterate as driving them to keep open the potential to cut rates.  In some respects it may be a better strategy to talk dovishly but keep more scope to cut next year if required.  The RBA certainly appears to have had this in mind when it chilled out until next year, sitting back with a cold one to watch the ECB and Fed 16 Dec rate decisions.

This is probably why the market has dropped its probability of rate cut by the RBNZ to below 50/50 even though bank analysts that are more reluctant to change forecasts and sticking mostly to their calls for a cut.

The RBNZ is more inclined to adjust policy when it releases its quarterly statement on monetary policy, and this is a MPS release date, putting a bit more weight on the rate cut scenario.  But I wouldn’t place too much emphasis on this; the over-riding consideration is if it makes sense or not at this juncture.  The RBNZ can just as easily see the MPS as an opportunity to more deeply explain a decision not to cut and set out its reaction function with an easing bias.

The reality is that there is not much that has changed since the RBNZ left rates on hold on 29 October.  It is only six weeks on and the RBNZ needs to decide if it is time to act on its easing bias or not.

I am leaning towards it’s not time and they will instead just leave the bias to ease intact.

So wrapping up and soon heading out, and faring a fond and a bit emotional farewell to Singapore, I am square and in a better place to up-date my performance page, probably this weekend.  It will be OK, but not as good as it could have been.

As I get going next year I will be working more on my business plan for expanding into advisory and managing capital.  So if you would like to tap deeper into my views keep in touch.  I’d like to be able to offer various avenues and am open to suggestions.

I have been working out of the office of Kit-Trading that is setting up a business model to partner with traders in various asset classes, by helping them increase leverage or establish a marketable fund.

I’d like to be in a position to offer customers the potential to invest directly in my trading strategies, provide a currency overlay product for asset managers, and provide more direct advice to those that prefer that arrangement, perhaps with a performance based fee.

My AmpGFX reports are free on-line to those that register and I encourage you to share the emails and links with your contacts.  I see it as an avenue to advertise my presence in the market.

If my business grows and I generate revenue I’d like to be able to build up the research capability both to improve the quality and scope of my company’s trading ability and the research reports it provides.

I’d like the company to maintain a research report writing capability, but the direction I think makes most sense at this stage is to generate performance-based income.  In the end, the success or otherwise of my venture will be in the ability to make profitable calls on the market not just write interesting articles that generate subscriptions.

The two complement each other in that at least you know that reports are written from the perspective of trying to find the best strategy not just wax on the merits of policy and economic activity.

Please keep in touch, spread the word, let me know if you have any ideas on how I might achieve my goals, and indeed if you have an interest in investing in my strategies or advisory services.

Kind Regards,

Greg Gibbs
Director, Amplifying Global FX Capital
+65 9238 0264