Fed's Twist, ECB's Turn, Euro Shouts

by Ashraf Laidi
Sep 22, 2011 0:37 | 21 Comments

The FOMC has done what was expected via Operation Twist; buying the same amount of Treasuries ($400 bln) as much it will sell, thereby maintaining the size of its balance sheet at $2.87 trillion. This explains today's jump in USD. And the fact that the Fed stayed away from cutting interest rate on overnight reserves is another positive for USD & negative for equity indices.

Most market observers were correct in expecting Operation Twist rather than outright QE3. It was highly unlikely for the Fed to adopt an aggressive easing less than 1 week after delivering coordinated USD injection operations with the major central banks. These central banks need to preserve armory for more troubled times ahead (later this year). For now, they will tackle the yield curve and worry later about raising net expansion of liquidity into the system.

We repetitively mentioned to our Premium subscribers that the Feds twist operation will be USD-positive as long as it constitutes no increase in the Feds balance sheet. We mentioned this at the September 8 interview on BNN

EURUSD Cycles & Policy Divergence

Monetary policy dynamics between the ECB and Fed have largely driven EURUSD cycles over the past 5 years. Each upcycle in EURUSD was boosted by Fed easing and relative ECB hawkishness. (see chart below on the right) The Operation Twist will be inadequately dovish to weigh on USD. Especially negative for the euro is the ECB's ensuing switch into easing mode via asset purchases and the eventual cut in its refi rate.

Germany's Looming Contraction (Yes, Germany)

Click To Enlarge
Fed's Twist, ECB's Turn, Euro Shouts - German ZEW PMI Sep 20 (Chart 1)

The justifications for a lower euro have been primarily focused on a looming default of Greece, inadequate size of the EFSF and Italy's unsustainable debt situation. But Tuesday's release of Germanys ZEW investor survey signals that the Eurozone's largest economy is at risk of a looming economic contraction. The ZEW's Current Situation index for September fell below 50 for the first time since June 2010 (a time when Eurozone was dragged by the Greece/Spain/Portugal downgrades), while the economic Expectations Index deteriorated to its lowest since December 2008.

The chart above clearly illustrates that a contraction (sub-50) in the ZEW current situation index (red) has led to a contraction in both of Germany's services and manufacturing PMIs (lower chart). This time it should be no different. As Germany's economic dynamics worsen, they will force the ECB into more activist easing, with an emphasis on boosting growth, while relegating inflation priorities to statistical records.

Trichet Confirmed ECB Shift Ahead of Fed's Twist

The ECB side of the ECB/Fed rate divergence is already emerging. In an Tuesday interview with Spain's Expansion, Trichet described the recent shift in the ECB's economic outlook as "significant", confirming that growth risks are to the downside and inflation risks are broadly balanced. While the comments are no surprise considering this months ECB press conference (which emphasized growth concerns), they highlight the current process of ECB dovishness, which serves to offset the negative USD impact of the Fed's moves into further asset purchases.

EUR-USD Libor Spread to Extend Decline Despite CenBank Injections

Click To Enlarge
Fed's Twist, ECB's Turn, Euro Shouts - EUUS LIBOR EUSD Mnthly Edited On Sep 21 (Chart 2)

In our September 14 note to clients we argued: "The cost of USD funding as measured by USD 3-month LIBOR hits 0.347%, its highest level since August 2010. USD-3-month LIBOR has risen by over 40% in 2 months (was 0.25% in July), a pace not seen since spring of 2010 when euro fell 22% against the US currency. As Eurozone banks rush into raising USD funding to alleviate the unfolding liquidity crunch, the cost of USD funding will further increase, thereby boosting USD. This has now reduced the Euro-USD LIBOR spread to a 3-month low".

1 day later, the central banks of the US, Eurozone, Japan, England and Switzerland injected USD-creating liquidity facilities for those European banks encountering difficulty borrowing in USD.

The EUR-USD spread shall continue to deteriorate and EURUSD is set to extend its path towards our preliminary target of $1.29 (mentioned last week) in light of evolving fundamental and technical dynamics. $1.29 is seen well before year-end, followed by $1.18 in late Q1 2012.

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Comments (Showing latest 10 of 21) View All Comments
Fuzhou, China
Posts: 1
11 years ago
Aug 21, 2012 3:48
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Gomel`, Belarus
Posts: 4
11 years ago
Aug 14, 2012 11:29
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Melbourne, Australia
Posts: 18
12 years ago
Sep 30, 2011 6:59

In today's premium, which order would you execute the short EURUSD trades, or does it not matter?

Since EURUSD has recovered a little I've put in an order for the 1st trade. So would I execute the second one once price has dropped to that level?

Posted Anonymously
12 years ago
Sep 30, 2011 0:28
Roland.. after two days of trying premium.. i agree..
Posted Anonymously
12 years ago
Sep 29, 2011 22:17
Ashraf, Dave, Oshun123

Thank you for your replies and comments.

Dave, your two points are well taken. These are the times to stay nimble and try to preserve rather than make huge bets.

And, Ashraf, no, thats not too long term (say, by the FOMC meeting in December?..)
Vienna, Austria
Posts: 3
12 years ago
Sep 29, 2011 20:17
I just wanted to make a short comment about the premium service.

I started following the signals about 3 weeks ago and have to admit that until now I experienced the trades losses and winnings to be more or less canceling out each other leaving my account size almost unchanged, but I really love the fundamental analysis offered and this gives me a completely new inside into trading. I do not consider the premium trades as bad but I think one has to include this trading ideas into its own trading framework, account size and risk preferences.

AL's trading ideas give me the big picture, as a short time intraday trader I do not follow the signals strictly but they give me the trade direction. Entry and exit points are determined by pure price action in my case.

I consider AL's analysis very high quality and therefore I will stay with the premium membership as it is unique, but I have the impression the trade ideas are not always the best if you consider them as the "holy grail".


Ashraf Laidi
London, UK
Posts: 0
12 years ago
Sep 29, 2011 19:16

Right on.


Let us suppose you agree with me and are confident that EURUSD shall hit 1.29-1.30 and agree that key resistance stands at 1,37 (or say 1.39 for example), would you then consider opening a short position near 1.35-1.36, targeting 1.30, with a stop at 1.38?

That's how the "big boys" do it. What say you?

OR is that too long term?

Posted Anonymously
12 years ago
Sep 29, 2011 11:05
usikpa, I think "major fundamentally driven moves" are currently difficult to predict with the global economic chaos prevailing. You could bet on another financial crisis far more serious than the last one, complete meltdown which is very high probability, but the risk is that it might be avoided. You could bet on ecc dissolving. There are too many major unknowns to be trading larger timeframes at this particular time imho.

Ashraf used to trade his opinions with no regard to 400/500 pip drawdowns but if his call proved wrong it had the potential to cause severe pain to novice traders following him. Now he has gone to the other extreme scalping the markets for his premium service. By scalping I mean looking for 40 to 100 pips typically. This results in less pain when he reads the markets wrong.

He is probably right about the 1.29 level or even a lot lower than that but it would be difficult to nail the timing. Its safer to trade smaller moves in the mkts as fundamentals are dynamic, never more so than in the last 4 yrs.
Moscow, Russia
Posts: 77
12 years ago
Sep 29, 2011 8:32

I respect very much what you do, but your Premium service, I understand it, is for intraday speculators, which just isn't my cup of tea. I try to follow major, fundamentally driven moves.
Posted Anonymously
12 years ago
Sep 26, 2011 11:48
Ashraf, my point was need to state "trading" timeframe when talking about corrective moves. Your premium service "trading" timeframe is intra day whereas your broader analysis commentary can be much larger timeframe. Usipka didn't state his trading timeframe unless that is he was looking to short 4 days ago for your 1.29 next forecast. EWA poke accepted but doesn't change my point.