Diary of a Financier

ECB sovereign QE conditionals

In Capital Markets, Economics on Fri 16 Jan 2015 at 16:30

Mark my words…

  1. If ECB announces €500B in sovereign QE

    Bund yields rise / Peripheral yields fall
    (Compression trade as intra-EMU capital flows from safety into higher yield sovereigns)

    FEZ rallies
    (Risk on)

    EUR strengthens
    (International capital flows into region to participate in asset reflation)
  2. If ECB fails to announce sovereign QE

    Bund yields fall or stay flat / Peripheral yields rise
    (Intra-EMU capital flight to safety)

    FEZ corrects
    (Risk off)

    EUR weakens
    (International capital flows out of region to avoid deflation)

~~~~

We’re maintaining our overweight position in the currency-hedged $HEDJ index.  As of today’s trading, HEDJ daily/weeklywe’re taking new, marginal exposure to Europe via $FEZ in expectation that EURUSD will head higher from here.  The marginal exposure is because this tactical trade is largely dependent on sovereign QE implementation, and a short-Euro posture is at least some FEZ daily/weeklyhedge to blunt the downside were that not to transpire.  Naturally, we’re poised to swing all of our European exposure into an unhedged FEZ and ADR singlenames — were QE announced.

This trade — as well as a strengthening Euro outlook — is pretty contrarian stuff, and here’s our rationale…

First, consider the intuition of the progression above, which is derived empirically from the trends in global capital markets over this past year plus.

Second, the EUR has strengthened historically throughout the Eurocrisis upon announcement of every stimulus measure. For the EMU, this is existential. That’s in stark contrast to other QEs, such as the United States’ — the latter being merely currency debasement (at worst) in order to stave off mere depression — as opposed to existential dissolution. QE is another vote for EMU solidarity. It’s a big vote for the Euro, thereby promoting its future value.  Getting through Greek bailout renewal/renegotiations is another powerful catalyst in that vein, which upside would be manifest were the ECB to merely broadcast a contingency plan to handle Grexit.

You also now have the SNB buying EUR en masse after shocking the world this week by breaking their EURCHF 1.20 peg.

Finally, as I’ll note in my Top Newsstuffs this weekend:

“I’m now a USD bear due to: unanimous consensus to the contrary; the Fed’s raising rates to end ZIRP is almost priced-in (see DXY +17% since 2h14 & flat yield curve); further DXY upside would inhibit GDP (lower exports), and ECB sovereign QE will actually strengthen EUR, as stimulus has historically welcomed capital back to EZ throughout the Eurocrisis; nobody seems to acknowledge that there’s no true arbitrage in Bund/Tsy spread, since the delta is currency risk!”

–Romeo

Previously: The most important post on Europe you’ll read this year

$EUR $FEZ $HEDJ#Mario Draghi #Germany

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  1. Correction on the “flat yield curve” point…
    Treasury rates don’t sync w US fundamentals (e.g. nominal GDP), but the curve is steeper than I thought in historical context:

    Previously: https://thebuttonwoodtree.wordpress.com/2014/06/01/the-bond-market-is-always-right/

  2. […] yield curve); further DXY upside would inhibit GDP (lower exports), and ECB sovereign QE will actually strengthen EUR, as stimulus has historically welcomed capital back to EZ throughout the Eurocrisis; nobody […]

  3. […] positions: net longs has reached record extremes [Previously: I’m a USD bear & Euro selloff has overshot downside] $DXY $UUP $EUR $FXE […]

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