Just a quick one. I note in the example given relating to EURUSD macro in the lesson
“I will give you a simple example of this macro model in work. Take the EUR/USD situation in July – September 2012. The EUR/USD stabilized around the 1.2000 level as the ECB said that they would take further action to save the Eurozone. That led to a few hundred pips of bullish EUR/USD order flow which was Scenario #1. Then as the details emerged of the ECB bond buying plan, the EUR/USD rose further a few hundred more pips, which would be bullish scenario #2. Then after the order flow from those scenarios was already generated, there was Scenario #3 that caused more bullish EUR/USD order flow. The Scenario #3 was the Fed hinting at and engaging in Quantitative Easing 3.0.”
Just to clarify isnt secario 1 and scenario 3 a similar catalyst, meaning 1 would devalue the EUR as scenario 3 would do as well to USD. Or was it because ECB was not printing money to purchase assests like the US.
What a great question!
Well, I would label them different scenarios. My thinking would be:
Scenario1: ECB rhetoric that they would save the EUR: creates some shock value as if there was, lets say 800 pips of macro selling based on expectations for EUR disorderly collapse, then some of those shorts start to cover. Lets say 300 pips worth of short covering.
So lets say the EUR/USD rose 300 pips from 1.20 to 1.23 lets say. The other 500 pips worth of macro sellers, lets say they don’t cover, because they want to see if the ECB is for real or not.
So when the details of the ECB bond buying emerge, those lingering macro shorts that didn’t want to cover, now want to cover with that added information flow component. So they start to push the price higher by another few hundred pips. Lets say EUR/USD rises from 1.23 to 1.26.
Up until that point, the EUR/USD was rising based only on EUR specific macro forces. The USD element was dormant.
But eventually the Fed indicated that they could do QE 3.0, so that added a fresh bearish USD element, causing EUR/USD to rise another few hundred pips.
Thus the three scenarios were chained together.
If you are referring to why the ECB bond buying did not devalue the EUR. There are numerous reasons. Firstly, because it was never activated. They laid out the conditions for if the OMT program, but no country activated the program. But the program was successful in lowering yields as no one wanted to short the sovereign bonds of those countries because the ECB might step in to buy them. So they didn’t want to short those bonds in front of those potential future massive bids.
Another reason is that it depends on what the market is pricing in, and why the bond purchases are done in the first place. If the EUR is being sold down 1,000’s of pips due to expectations for EZ breakup, then an announcement of bond buying, while traditionally can debase a currency, can actually cause the EUR to rise in value, since those macro players betting on EZ collapse, now have to cover their shorts as with the ECB bond buying, the chance of that scenario playing out are much less.
With the Federal Reserve, the situation is different. They did bond buying to boost growth, employment and prevent deflation. So the market said to itself “Gee, growth in the US may be weak, inflation may be low, and the Fed is going to be buying up all these bonds to try to lower interest rates and keep them low for longer. Time to short the USD.”
The ECB did bond buying, first and foremost to try to reduce the risk of disorderly collapse, which led to reduction in bond yields, which in end aids the growth, employment and inflation prospects, etc. So the market said to itself: “The EUR has already dropped 1,000 pips as a lot of macro players betting on collapse of EZ. But the ECB rhetoric and program and prevent that collapse, so time to cover EUR short, and maybe flip to long EUR.”
The Federal Reserve’s goal was to lower interest rates for many different things – mortgages, corporate bonds, etc. And in pledging to keep rates so low, etc it created dollar weakness.
The ECB’s goal was to remove the tail risk of EZ collapse, and to reduce the high spreads between French and German bonds from the Spain, Italy, etc. The ECB felt that the yields for Spain and Italy, etc were too high. So they wanted those to be lower. They didn’t care much for French or German yields.
The Fed’s QE was bearish because they actually bought hundreds of billions and trillions of the bonds, etc while the ECB hasn’t activated the OMT program yet. And it also had to do with the market expectations that I talked about above, where the EUR was weak due to risk of collapse, but the ECB stepped in and removed that risk of collapse, so the bearish macro had to unwind.
Now, if the ECB did QE in the current market environment, the only reason they would do it, is to try to boost growth and boost inflation, etc. If they did do that, then there is possibility that it can be highly EUR bearish. Many Fed officials have given statements that the ECB should do QE, but most members of the ECB don’t currently think it is necessary.