FX Update: Narrative around the ECB more important than the particulars

Trading interest

• Staying long AUDNZD with stops below 1.0570 and targeting 1.0950

Risk appetite was boosted yesterday by both Chinese and American overtures on the trade front, as the former announced exemptions on tariffs for a number of product categories and the latter delayed the October 1 tariff raise to October 15 in respect of China’s National Day celebration. USDCNY traded down well below 7.10 into this morning and Asian markets and currencies in general celebrated this “breakthrough”, with the hope now that an October visit to Washington from Chinese . Trump’s firing of security adviser Bolton may be adding to risk sentiment at the margin as well on the hopes that he would prefer to default to avoiding geopolitical confrontation now for the duration to offer maximum support to the economy through next year’s US presidential election.

Today is ECB meeting day, with many items on the policy menu. First we are most likely to see an implementation of tiering of interest rates assessed on bank reserves akin to the Bank of Japan’s system in an effort to reduce the pain on EU banks affected by negative interest rates on their reserves (particularly an issue for German and French banks). Second, we will get a rate cut. Rate cuts are so futile I don’t understand why the ECB bothers, but that won’t stop them from delivering one. Given that Draghi is running out of time and will want to impress, a 20-bps cut might be a bit more likely than the market odds are pricing it at (about 40/60 for 20 vs. 10 bps).

The area where the ECB can surprise most is on the QE front, as renewed QE is clearly controversial on the ECB governing council and where estimates vary from EUR 20B to EUR 60B per month (consensus somewhere in the middle). Beyond these measures, however, it will be important to draw a signal during the press conference on whether Draghi gives the impression that the ECB is shooting its last bullets here or maintains the ability to continue to act. We think not – from here the power is in the hands of the EU and its political leadership as the central bank put has almost entirely lost its potency. In particular at today’s meeting, guidance that feels like Draghi improvising rather than expressing the view of the Governing Council will need to be taken with an extra grain of salt as this is his penultimate meeting.

Chart: AUDUSD
Yes, it is ECB day, but the key axis in the ECB reaction will likely be along the lines of risk appetite and whether the market can maintain the position that the central bank put remains effective and operational in the wake of whatever Draghi and company deliver today. So all of the risk/safe haven pairs, whether AUDUSD or NZDJPY or EURJPY could move in strong correlation once the market makes up its mind about the effect of new ECB easing beyond the headlines. On that note, a pair like AUDUSD is up against the wall, arguably needs to fade ahead of the 0.6927 retracement to maintain bear trend status that has been in place since early 2018.