Expect Aggressive Move By ECB Next Week To Stimulate

Key Issues

• 1. SNB scraps floor on EUR/CHF in pre-emptive move ahead of ECB
• 2. ECB to deliver aggressive QE at this week’s meeting. Potential for decline in German bund yield limited, periphery will benefit and EUR/USD moves South
• 3. SNB could force more easing by Scandinavian central banks
• 4. Labor market slack debate resurfaces in US after fall in wages
• 5. Markets postpone first rate hike in the US to end-2015

SNB abandoned the floor on EUR/CHF

The Swiss National Bank (SNB) surprised the market by abandoning its 1.20 fl on EUR/CHF and simultaneously lowering the target range for the Libor interest rate by 50 bpts to between -1.25% and -0.25%. The interest rate on the night deposit account was similarly cut by 50 bpts to -0.75%.

The SNB has regarded the EUR/CHF fl as an unsustainable monetary policy due to possible QE from the ECB and increasing divergence between monetary policy in the Euroarea and the US.

As seen in the chart below, the SNB’s balance sheet has expanded much faster than other major central banks’ and is now close to 100% of GDP. It is possible that substantial safe-haven cash inflows in December and January, not least of which from Russia, forced the SNB to step up its intervention in the FX market.

It looks like a fundamental change in the framework for the SNB’s monetary policy although it indicated that it will continue to intervene in the FX market.

Within this new monetary framework there appears to be a larger reliance on interest rates.

In the short run, we could see more appreciation pressure on CHF from both QE and possible safe haven inflows from uncertainty in connection with the Greek election and Russia economy. Meaning further interest rate cuts by the SNB cannot be ruled out.

The move by the SNB is regarded as a pre-emptive move ahead of next week’s ECB meeting. The move has increased expectations that the ECB will deliver a relatively aggressive QE program next week and bond yields have fallen globally on the back of the SNB’s move.

By loosening its peg to the EUR, the SNB creates expectations that the bank will diversify its FXreserves from EUR. This adds more Southside pressure on the single currency.

Also, the move tells us that there could be a large spill-over effect to other European central banks, not least the Scandinavian ones, due to potential QE by the ECB. So, it cannot be ruled out that some will even start to question the sustainability of a peg to the EUR, but we do not expect Denmark’s EUR peg to be questioned, yet.

HeffX-LTN expects the ECB to deliver an aggressive QE in connection with next week’s ECB meeting.

The ECB is likely to announce a bond purchase program of EUR750-B running until September 2016. This is more than most analysts expect, because the implication is that the monthly purchases will be large and the pace of purchases will be more important than the size of the program.

Despite our expectations of a relatively large QE program, the potential for a further decline in bund yields is probably limited in here. The peripheral spreads should tighten further Vs Germany and Portugal is set to be the biggest beneficiary.

Finally, expect EUR/USD to continue to move South.

Downward pressure on EUR/DKK is growing following the SNB’s abandonment of the EUR/CHF peg, and the pressure could intensify after the announcement of the QE program.

That said, expect the Danish central bank to cut its deposit rate twice by 10 bpts to -0.25% in Y 2015 with the 1st cut in Q-1.

Notable

On the surface, the headline US labor market report for December was strong. NFPs (Non-farm payrolls) in December increased 252,000 and, for Q-4 as a whole, the average monthly gains in NFPs improved to 289,000 from 239,000 in the prior Quarter. And, the unemployment rate declined markedly to 5.6% from 5.8% and is now at its lowest mark since May 2008. The US Fed estimates that that the unemployment rate consistent with ‘full’ employment is in the range of 5.2-5.5%.

But, according to the household survey, the decline in the unemployment rate was largely due to a continued decline in the labor force and the labor force participation ratio continues to decline. More importantly, growth in average weekly earnings in the private sector eased to just 1.4% Y-Y from 1.9% Y-Y in November.

Add to that, US retail sales were a big disappointment in December, dropping 0.9% M-M. Lower gasoline prices and weak auto sales weighed on retail sales in December, but even excluding gasoline and autos, retail sales declined 0.3% M-M in December. This indicate to me that the world economy’s only relatively strong growth engine may not be running as strong as many think.

by HeffX-LTN  -- Paul Ebeling