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Critical ECB Meeting Looms As Euro Lies Low

As the euro tests 11-year lows against the greenback on Monday, worldwide investors await the outcome of this week’s all-important European Central Bank (ECB) meeting. Will the ECB take its most aggressive action to date to slay the beast that is deflation and save the flagging eurozone’s economy with a sufficient bond-buying program?

Rate divergence is a major trading theme for 2015. Yet no one expected the imminent impact of varying rate policies so early in the new calendar year. For months the market has been focusing on the Federal Reserve or the Bank of England to hike interest rates, but both banks have pushed the timing to do so further out the curve. Now there’s a real possibility that the ECB will introduce its own quantitative easing (QE) policy. In light of these events, investors have to broaden their horizons to include Tier II central bank policies, the proactive measure undertaken by the Swiss National Bank (SNB) last week, and the impacts that the Swiss action may have on other national central banks in the euro region. Currently, Scandinavian banks are joining the Danish government in trying to persuade offshore investors that the Nordic countries will not copy the Swiss and drop their euro pegs — the diverging rate storyline has gotten far more interesting.

Markets Await ECB Decision on QE

The next five trading sessions will be dominated by central banks, as various governors, presidents, and policymakers remain front and center throughout the week. While the Banks of Japan and Canada take the lead in the first half of the week, investors will be focusing intently on President Mario Draghi and the ECB on January 22, when the possible introduction of a sovereign debt-buying program tops the bank’s agenda.

Although the consensus is for ECB interest rates to remain unchanged, the market has been pricing for expectations that it will extend its program of asset purchases to include sovereign as well as corporate bonds. Let’s hope so, especially after the SNB’s costly action that did away with the CHF currency cap last week. It was a non-transparent policy move, and the repercussions will be felt for many months to come. The surprise Swiss decision indicates that investors cannot afford to be complacent with central bank rate decision announcements any more.

SNB’s Damage Control Ongoing

Investors were sideswiped not once, but twice last Thursday when a number of central banks altered their policies. The Reserve Bank of India (RBI) eased monetary policy by -25bps to +7.75% just two weeks before its regularly scheduled meeting, and has set off expectations of more cuts to come. At the same time, the SNB removed the three-and-a half-year-old currency cap of €1.2000. President Thomas Jordan’s actions (an about-turn from all the public rhetoric) shocked markets and it had a massive global impact. Swiss officials have been in damage control ever since, but they expect markets to stabilize, adding the cap on the franc was no longer justified as the Swiss economy was improving. Jordan also said the “exchange-rate situation will remain under consideration in future decisions, and the minimum rate risked loss of monetary conditions through an inflated balance sheet.” Can anyone safely decipher this cryptic message?

The SNB undertaking was an historic outcome and move, which both dealers and investors will be tallying for weeks to come. The lack of transparency by the SNB’s decision has unnerved investors and possibly changed the central bank rules for the lesser knowns. The SNB has lost much street credibility and its actions still raise the possibility of future unanticipated moves by other central banks.

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