The European Central Bank is very conservative at the time of taking decisions on economic policy. And this fact has been confirmed again today. As expected, the ECB will cut asset purchases to 30 billion euros from 60 billion euros. This will start in January and it will last for nine months to September. One of the reasons why the ECB remained cautious is the weak inflation.
What did the EURUSD?
After the decision, the Euro plunged.
Source: TradingView, EURUSD Dec17 Future, 30 min
The market didn’t expect a hawkish decision and it was reflected in the movement of the euro. I started the day falling. You can see how the volumes got bigger around the interest rate decision and the ECB conference. Draghi was optimistic about the eurozone growth but he signaled that is concern about the inflation. Technically, the EURUSD futures has broken 2 important levels (1.1793 and 1.1729)
What is the real reason behind this decision? My opinion
Economics is a social science and predicting the individuals' behaviour is really difficult. Let me make an example to show my thoughts about this dovish decision.
Let’s imagine an ideal world in which the most important economies keep performing like the last couple of years, China’s GDP growth meets the 7%, the commodities keep rising, the Federal Reserve raises rates and makes substantial cuts to the asset purchases and there isn´t any economic shock. In this context, the US dollar will rise vs the euro. The conservative ECB policy will support a weak euro, and with the conditions mentioned, it will help Europe to keep growing and the inflation will peak.
On the other hand, applying the economic policy in Europe is difficult due to the differences between the strong economies and the peripheric economies. So whatever is applied needs to be good in general terms without affecting in a negative way to certain economies.
As a theory, it’s valid but it’s very difficult that all of these will happen.
What can we see in the Euribor futures?
Euribor futures are the interest rate futures in Europe. You will see in the following charts that an improvement of the European economy is not discounted.
Euribor Jun18 future
Source: Barchart, Euribor Jun18
As you can see it fell at the beginning of this year, showing an improvement of the economy. At this time the inflation was growing and it hit 2% in March. The euro was weak in this period, the EURUSD was trading around 1.06. Since then, the Euribor jun18 has been rising due to the low inflation, the Brexit, the lack of change in the economic policy. Considering the uptrend, the market participants don´t expect changes in the economic policy neither a big improvement of the European economy.
Euribor spreads
Euribor March 18 – June 18
Source: Barchart, Euribor Mar18-Jun18
Euribor March 18 – December 18
Source: Barchart, Euribor Mar18-Dec18
These spreads show the same as the outright explained before. A falling spread means that the difference between the two futures is decreasing. Talking about the interest rate curve, we can see that the yield curve is flattening. The main difference between both spreads is the volatility. Obviously, the 9-month spread moves more than the 3-month spread. They are in lows of the year, I would consider buying if I expected an economic improvement. At the moment, I wouldn’t buy because I don’t see any sign of reversal.
Another strategy to consider is a Euribor butterfly.
Source: Barchart, Euribor butterfly Jun18-Sep18-Dec18
The butterfly is in a support and it´s trading at the lows of the year. I think it´s a better choice than the spreads at the moment.
Euribor spread June 18 – June 19
Source: Barchart, Euribor Jun18-Jun19
The main difference with the other spreads is that the overall trend is bullish. This means that the traders expect that the economy and the inflation will be better in 2019 than 2018. The main problem is that the triangle is one of the most dangerous figures in technical analysis and I wouldn´t trade it until it breaks. If you like interest rate futures you should add to your watchlist. There is a strong support at 0.1550.
Conclusion
First of all, I hope you enjoy this article. The interest rates market is my favourite. You should consider the macroeconomic indicators and follow the central bank meetings. It’s a fundamental market and less volatile than other markets. There are strategies such as spreads and butterflies that are listed at the exchanges so you won’t have execution problems in the different legs. Thanks.
Have a good trading!
Disclaimer
I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved
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