What to Expect From the ECB

The ECB will push the limits of monetary policy on Thursday, but how far? The Swiss franc was the top performer on Wednesday while the pound lagged badly. We also review the themes after a busy day of trading. Ashraf's 3 short positions in GBP crosses have deepened in the green. A new Premium  trade will be issued befire and after Thursday's ECB decision and Yellen's testimoney.

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Broad expectations are that the ECB will increase QE by 10-20 billion per month for at least another six months. They will also lower the deposit rate by 10-20 basis points.

But it's much more complicated than that. There is reason to believe the ECB is supply constrained in terms of QE so pledging to buy as much as 660 billion more bonds isn't as straightforward as it seems. Officials have floated the idea of buying city/regional bonds or even bundled bank loans as options. That signals expectations may have gotten ahead of themselves.

Along those lines a leak from the ECB on Wednesday to Bloomberg indicated that ECB staff forecasts were barely changed with a reduction in the 2017 inflation forecast to 1.6% from 1.7% as the only notable change. They hinted that officials may highlight other risks as a reason to take more action but the hawks will have plenty of fodder to push back.

The deposit rate is an underrated tool. The Swiss experience has shown it to be a powerful weapon and the ECB could counteract a disappointing QE number with a larger deposit rate cut or a hint they will cut the deposit rate further in the future. The ECB had gone through the deposit rate floor was -0.20% but the Swiss and Danish experiences have shown it could be at least 55 basis points lower.

What's interesting is that any move on the deposit rate will be delivered in the ECB statement while a QE announcement wouldn't come until Draghi's press conference. If the deposit rate cut is larger than expected, the subsequent drop in the euro may prove to be the only opportunity to sell because the QE number could be a disappointment 90 minutes later. But then comes Yellen's testimony and Friday's NFP, which will likely limit any bounce for the single currency.

In the US, commentary from Yellen made it overwhelmingly clear that she favours a rate hike. The Fed has been looking for confidence on inflation moving back to 2% and Yellen emphasized more than once in her speech that she has it. Lockhart was also overtly hawkish while Brainard's dovish musings were largely ignored by the market (perhaps incorrectly). If there is a surprise at the Dec Fed meeting, it will be that the governors were dead against a hike.

Other developments in US trading including a stronger ADP report, an rather upbeat Bank of Canada and crude breaking $40 once again. The S&P 500 also posted an outside day after a 23 point fall.