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May 25, 2015

Whatever It Takes: Don't Fight the ECB

"Don't Fight the Fed" has long been a central tenet of financial markets and one of the most profitable trading strategies around. This week confirmed - if there was any doubt - that "Don't Fight the ECB" is just as central, and equally profitable.
A speech in London on Monday from European Central Bank Executive Board member Benoit Coeure about tweaks to the bank's bond-buying programme, or quantitative easing (QE) caught the market on the hop and triggered one of the euro's biggest falls for years.
Coeure's audience was a select group of hedge fund managers and investment bankers. They received market-moving information at least 12 hours before the media and wider public that the ECB could step up its bond-buying programme in May and June.
Giving this highly sensitive information to an invitation-only audience sparked a tidal wave of criticism of the ECB.
As soon as markets got hold of the news, they moved. The euro lost 1.5 percent against the dollar, putting Tuesday among a handful of biggest daily losses since the depths of the euro zone debt crisis in late 2011.
Coeure's remarks were confirmation that the ECB is flexible in its approach and will do "whatever it takes", as famously announced by his boss Mario Draghi in July 2012, to achieve the ECB's goal of killing off deflation and bringing inflation back to target.
Traders would be brave to go against it. Even if the entire market seems to be a buyer of European stocks and valuations are the highest since the euro's launch, according to some metrics, most are looking to maintain exposure by carefully choosing country or sector.
Deutsche Bank said on Friday that a snapshot poll of clients at a recent conference showed that their top three favoured trades were short euro (53 percent), long European equities (33 percent) and long German Bunds (7 percent).
Effectively, 93 percent of those polled were making bets directly related to the ECB's policy of QE, which will see the central bank buy about 1 trillion euros of bonds through September next year.
So perhaps it was no coincidence that Coeure lobbed his grenade this week after a month of rapidly strengthening euro and rising bond yields which had resulted in an unwelcome tightening of financial conditions across the 19-nation bloc.
It was clear that the ECB was uncomfortable with a 15-fold rise in the Bund yield and 9 percent euro rally in only a month.
"Although they won't admit it, those comments show ECB has an eye on the euro," agreed Jeremy Stretch, head of currency strategy at CIBC World Markets.
"The rise in the euro has caused a tightening in monetary policy and that is definitely not a scenario that the ECB wants."
Before Coeure spoke on Monday, the Bund yield was just under 0.7 percent and the euro was just under $1.15. On Friday, the yield was back down at 0.6 percent and the euro was $1.1150, posting its first weekly fall in six weeks.
Draghi's impact on financial markets since he replaced Jean-Claude Trichet at the helm of the ECB in November 2011 has arguably been as great as that of any central banker in history.
In July 2012, with the euro zone debt crisis and soaring borrowing costs threatening to rip apart the monetary union, Draghi said in an unscripted speech that the ECB would do "whatever it takes" to save the euro.
The borrowing costs crippling the so-called peripheral euro zone countries such Spain, Italy and Portugal collapsed, reaching record lows this year. The yield on some short-dated debt has even fallen below zero.
It took longer for stock markets to catch on. But they have been playing the "ECB QE trade" for some time and continue to do so, buying almost any stock in the knowledge ECB policy will be ultra-loose for well over a year at least.
Consultants Armstrong International this week published a survey of 305 North American institutional investors, which showed a record level of positive sentiment towards European equities on the part of North American institutional investors.
"It feels very much like a land grab," said the firm's chairman Martin Armstrong.
The latest monthly poll of global fund managers from Bank of America Merrill Lynch showed that euro zone stocks remained the No. 1 destination for equity investors in May. Only one in 10 managers polled was underweight euro zone stocks.
Data from EPFR this week showed that European equities have been attracting net inflows on a cumulative basis every single week since the start of last year.
This might suggest the "long" European stocks trade is overcrowded. Analysis from Morgan Stanley shows that the median price/earnings ratio is 18, the highest since the late 1990s and close to the all-time highs.
"It is certainly too early to fight the ECB. The ECB will carry on until September 2016 and possibly beyond," SteppenWolf Capital chief investment officer, Phoebus Theologites, said. 
Courtesy Wealth Management  

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