E Markets: Bruised

Markets are bruised and waiting for the ECB Draghi news conference. There is no expectation of anything substantial from today’s news conference other than confirmation of their end of QE and lower forecasts for growth and inflation. The ending of bond buying matters and its effects on markets will play out over the next year – just as the original QE took time to move risk appetites higher and volatility lower, so too the reverse will require months to notice. The overnight news wasn’t enough to help risk-takers in Europe ahead of the ECB – even with China’s new policy to open to foreign companies and talk of ending the 2025 Made in China plan, even with UK PM May winning her leadership challenge. But there are other negative stories like the SNB remaining steadfastly in the QE camp and cutting both growth and inflation forecasts – foreshadowing some other central bank forecast shifts; like the Chinese holding another Canadian in its diplomatic push to get the Huawei CFO release; like the rising risk of a UK Labour government. No matter, markets are on hold and waiting with the data overnight too light to matter and the price action over the last week too volatile to jump ahead of event risks. The measure of the bruising in FX remains the USD which isn’t going down despite all calls for it. There is clearly a risk around Draghi and his conference call today for a move – with 97.60 rather than 96 the issue.

Question for the Day: Is the USD overvalued? The RBA Bulletin has a chapter on modeling the forward AUD price. Central Banks and FX markets have a difficult relationship – as Former FOMC Chair Greenspan quipped in his book The Age of Turbulence: “… I knew that because of the efficiency of Foreign Exchange (Forex) markets, forecasting exchange rates for major currencies is as accurate as forecasting the outcome of the flip of a coin.” The RBA is attempting to flip the coin here – they model FX because its so important to the economy – this is how the Bulletin puts it: These models are used to assess how consistent the level of the exchange rate is with the level that would be expected based on its historical relationship with other economic variables – or ‘determinants’. These determinants are the terms of trade – the ratio of export to import prices – and prospective investment returns on Australian assets compared with those abroad, commonly captured by real interest rate differentials.    

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