Is a dovish ECB priced in?

Overnight saw AUD traders suffer minor whiplash as relatively supportive job report headlines inspired a brief spike higher in AUD before a fresh and heavy bout of selling set in, taking AUDUSD and other AUD pairs to new local lows. The unemployment rate drop to a new cycle low of 5.0% was flattered by a drop in the participation rate and the solid headline growth in payrolls was mostly down to part-time positions.

More worrisome was National Bank, one of Australia’s 'Big Four', joining its peers by announcing a hike to mortgage rates, prompting fears that the credit crunch will only worsen here and drive what a Bloomberg article calls a “doom loop of debt”. The only thing holding up AUD here is China’s insistence on maintaining a firm CNY and perhaps speculative positioning already rather short AUD, though some of that may have been cleared out by the recent rally.

The trajectory of European growth has been painfully clear in recent months, with speculation that Italy is already in recession and Germany possibly soon to follow, with European long yields punching to new lows for the cycle at the core and heavy interest for peripheral debt at recent auctions. The Spanish 10-year has plunged to a new low since last summer at 130 basis points this week.

European Central Bank president Mario Draghi has waxed far more cautious recently, but has claimed that the EU is not headed for a recession. Nonetheless, the market is expecting a dovish downgrade to guidance and for Draghi to even open the door for fresh easing – most likely in the form of a TLTRO – for the March meeting if the data deteriorate further from here.

Ahead of today’s meeting, we get a look at the latest flash manufacturing and services PMI for France, Germany and the EU, which could add a bit of color. The risk for euro bears – especially in EURUSD – is that a relatively dovish performance from Draghi is in the price and that the overriding issue of the US-China trade talks keeps traders sidelined on committing to USD trades until the outcome is known there.

The market is taking the “Article 50 delay” story as a near-sure bet and running with it, as GBPUSD blasted all the way to nearly 1.3100 before retreating and EURGBP probed below 0.8700. We wonder if this confidence is a bit too aggressive here – still some chance that the Remainers/delayers can’t put together a coherent plan that results in the soft Brexit getting back on the rails, as doing so might require some unprecedented breach of constitutional norms. Stay tuned, the heavy sloshing to one side means that two-way risk has picked up tactically on the “wrong” headline. Next week will be a dramatic one as we await the January 29 vote on May’s Plan B.

Chart: EURUSD

We’ll pull this chart out once again to point out the importance of the 1.1300 area, which was never punctured in any sustained fashion despite the nominal range low of 1.1218. A close below 1.1300 will require some participation from trend trades and could eventually approach the 1.1000 level, assuming that the market is not held back by the uncertainty of the US-China trade negotiations (we could be heading for dramatic headlines there next week as well on the Huawei CFO extradition situation, as the US has until January 30 to make its request). The surprise side – not anticipated but probably more appropriate given the limitations of monetary policy – is an ECB that shrugs its shoulders at weakness and claims that any notable policy move from here needs more involvement from the fiscal side if growth hopes are to be revived. Now that would be interesting…