Remember how the Germans turned their nose up at Quantitative Easing (QE) less than a year ago? They made all sorts of noises about “sound money” and European Central Bank (ECB) “overreach” of its charter.
Well, now they are secretly hoping that Super Mario will fire up the printing presses and deliver a Santa Draghi rally just in time for Christmas. For a very long time, Germany was the locomotive of European growth, but now they are quickly becoming an anchor across the neck for the Eurozone. The German manufacturing sector is the lifeblood of the economy and it has taken blow after blow in the third and fourth quarters. The Germans are not used to disappointment which is why Jens Weidmann, the imperial head of the country’s central bank refuses to publicly acknowledge the need for more Quantitative Easing… even as his economists continue to lower their own GDP forecasts for 2015.
Is Danger Ahead?
Yet Germans won’t be able to ignore the danger signs for much longer as the list of troubles continues to grow. Winter is coming, and between the VW scandal, slower Chinese growth and the influx of refugees, Germany faces major challenges. Close to a million refugees will be received in Germany and the government will need to spend even more money to house and feed these migrants. Some believe that the refugees are a godsend for German growth because their spending could add a quarter percent to German GDP but that won’t be enough to compensate for the pain caused by weaker growth in China and Fed tightening.
On top of all that, the Federal Reserve’s Hamlet act is creating major headaches for the ECB. Will the Fed finally hike? Federal Reserve tightening could knock the wind out of the Eurozone’s recovery and if the ECB fails to act soon, it could cost the Eurozone another 0.3% in GDP growth. But slower growth is not the only reason why the ECB needs to act. According to initial estimates, inflation turned negative in the month of September for the first time in 6 months. The ECB’s mandate is to maintain inflation near 2% and they are failing miserably. The rise in the currency, collapse in energy prices and weak global demand are creating deflation rather than inflation which can be just as big a problem for the region.
Will there be political hurdles? No doubt. But the ECB molded the original QE program to appease Germany and the Germans can’t possibly justify screaming loudly when they pose the greatest risk to Eurozone growth. December is the perfect time to act because a Santa Claus rally will be good for businesses and consumers.
So Where is the Opportunity in the Currency Market?
If you think the euro is cheap now it will only get cheaper if the ECB expands its QE program. Quantitative Easing will be the kiss of death for the currency. When the ECB unleashed QE1, EUR/USD dropped 10% in 6 weeks. This is a big drop but the real move started a month prior. For anyone who jumped in before the crowd to short the euro in December, gains would have exceeded 15% on a position held for only 2.5 months. If the German economy doesn’t turn around soon, the ECB will have no choice but to pull the trigger. For currency traders the question is, “Do you want to play offense or defense”? Offensive traders will avoid buying the euro at all costs and defensive traders will sell. Regardless, between the outlook for German growth and the prospect of QE, our target for the EUR/USD if the ECB goes QE is 1.05. Until next time, Kathy Lien