On December 3rd 2015, the European Central Bank met for its monetary policy review. The ECB decided to leave the minimum bid rate unchanged at 0.05%, but cut the deposit rate to -0.30%, from -0.10% a 20bps cut for deposits held at the Central Bank. The ECB then followed up the monetary policy decision with a press conference, where the Central Bank announced that it would extend the QE deadline from September 2016 to March 2017, while leaving the current pace of QE purchases unchanged at €60 billion per month.
During the press conference and into the end of the day, the Euro rallied close to 3.06% for the day, closing at 1.0938 and posting a 21-day high. Prices reversed sharply after initially opening the day (03/12/2015) at 1.0612.
So why did the Euro rally so strongly despite the ECB coming out dovish?
Timeline of EURUSD into December’s ECB Meeting
To begin with, the markets were extremely short on the Euro heading into the event. In fact, in order to understand the Euro’s surprising move, readers are to be reminded of the prolonged downtrend that persisted since October 22nd2015, when the ECB last met. It was during this ECB meeting that Mario Draghi came out strongly dovish noting that the Central Bank would decide on further measures including evaluating the current QE plan at the December meeting. EURUSD fell -2.03% on the day.
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With Eurozone inflation staying stagnant for the most part of this year since the QE program was announced in January, there hasn’t been any significant progress as far as Eurozone’s inflation was concerned, which hovered near 0.90% and 1.10%. With the October press conference noting the ECB’s willingness to look into its monetary policy measures, the markets started to price in a strong probability that the ECB would expand the size of its QE in December.
At the same time, since October, the US economic data continued to remain stable and positive thus keeping the US Dollar well supported against the single currency, the Euro. Since October 22nd, the EURUSD declined by a massive -6.39% through December 2nd. The declines in the EURUSD since October 22nd through December 3rd ECB meeting was also supported by intermittent speeches from various ECB officials who at regular intervals used their speaking engagements as an opportunity to verbally talk down the Euro. Members included the ECB President, Mario Draghi and other key officials of the Central Bank.
On October 28th 2015, the US Federal Reserve met for its monetary policy review. The markets were expecting to see a dovish Fed decision postponing the rate hike decision into next year. However, the Fed came out strongly hawkish noting that it was still looking into the December’s FOMC meeting to decide whether to hike rates or not. This strongly hawkish message saw the US Dollar being bought while the Euro was being sold. EURUSD fell -1.15% on the day.
By the first week of November 6th, 2015 the US Nonfarm payrolls numbers were released which came out surprisingly hawkish with the monthly payrolls beating estimates of 181k and rising 271k while the US unemployment rate fell to 5.0% from 5.1% previously. The strong jobs report added to the market conviction that the US Federal Reserve was poised to hike interest rates, thus highlighting the monetary policy divergence between the US and the Eurozone. EURUSD fell -1.35% on the day.
Into November 20th 2015, there were many speaking engagements by Draghi and other ECB officials which led to continued speculation that the ECB would expand the QE program. Some of the speculation doing rounds included rumors that the ECB could buy municipal bonds and Draghi’s comments at a banking forum in Frankfurt where he was quoted as saying that the European Central Bank must do what it can to “raise inflation quickly” EURUSD fell -0.84% on the day.
Euro Rallies on ECB’s decision on December 3rd, 2015
On the D-Day taking all the previous weeks into consideration, the markets were heavily expectant that the European Central Bank would launch another ‘QE Bazooka’. The expectations were for a deposit rate cut taking it into steeper negative territory and expanding the QE program from the current €60 billion while also extending the deadline to the QE or keeping it open-ended.
While the ECB delivered on almost all front, it refrained from expanding the QE size, which was one of the main reasons that the markets reacted to strongly with the Euro surging across the board, combined with a short squeeze in the markets as well.