The news that the ECB would reexamine its stimulus program at its meeting on December 3 – as well as consider cutting rates further into negative territory – came as a surprise to markets this week. This had a profound influence on various financial instruments, but it remains to be seen whether the medium- or long-term picture will be altered by such a move by the ECB.
Prior to this week’s meeting, a consensus was forming that questioned whether the ECB would be able to move at all this year and that its range of options – in terms of lowering interest rates or of finding adequate instruments to boost asset purchases – was limited. Draghi sought to dispel such concerns and sounded much more willing to take action than many expected. This led to a massive drop in the value of the euro – its largest one-day drop since January when Draghi similarly prepared the markets for stimulus before the ECB’s Quantitative Easing campaign was launched.
Furthermore, Draghi’s stimulus promise had a positive effect on risk assets, which were recently under pressure as Chinese economic growth slowed down and commodities – particularly energy – slumped. Extra stimulus from the ECB could help counter these negative factors, which led to powerful up-moves in assets such as stocks in the Eurozone and elsewhere.
In currency markets, the ECB Chief’s promise of more QE and possibly lowering the deposit rate even deeper into negative territory, reestablished the euro as a key funding currency. This represents a trade by which the euro is borrowed at a low interest rate and then sold in exchange for a currency with higher interest rates. Examples of higher-yielding currencies are emerging market currencies or developed country ones whose interest rates are much higher than zero – such as the Australian dollar (2.00%) and the New Zealand dollar (2.75%). The aussie and the kiwi have also been under pressure this year because of their dependence on commodities.
To sum up, the promise of more stimulus from the ECB has led to a significant rally in risk assets and higher-yielding currencies – as well as a drop in the euro of course. However, despite the impressive magnitude of the moves, it does not look like the extra stimulus from the ECB will be enough to drive certain key currency pairs (such as euro / dollar) or risk assets (such as the US or European stock indices) outside of their recent ranges – or indeed to stop the pressure on commodity currencies and emerging markets. Of course the technical situation will need constant monitoring in case such breakouts occur and the move does reaffirm the rather positive tone for markets during a seasonably favorable period until the end of the year.