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FXPRIMUS Market Brief of the Week: Threat of Deflation in Euro Zone Will Eventually Lead to Quantitative Easing (QE)

SINGAPORE, SINGAPORE -- (Marketwired) -- 04/08/14 -- In FXPRIMUS' Market Brief of The Week for 7 April, the brokerage firm's Senior Economist, Jimmy Zhu, looks at the threat of deflation in the Euro Zone.

Economic Insights

A Second Rhetoric will not work this time, as European Central Bank's (ECB) actions are needed

Are you familiar with the fabled story of "The Boy Who Cried Wolf"? Current market situation echoes the story. When Mario Draghi pledged his strong comments in 2012, market believed him and Euro-denominated assets rallied since then. However, EURUSD still stood above 1.37 last week. The influence of the jawbone was much less this time, as it goes in the fabled story, those "villagers" have not seen any "wolf" since 2012. Deteriorating inflation falling below 1% consistently in the past six months called ECB to take action in near term.

One positive change is that the QE appeared in the ECB's meeting last week. Draghi said that they did not discuss QE in detail previously, but they did discuss it in this month's meeting. They are also acknowledging QE's positive impact.

Strong single currency has been the key reasons why the recovery of currency bloc has been less resilience compared to the 2H 2013. Euro Zone manufacturing Purchasing Managers' Index (PMI) showed signs of peaking since 2 months ago, after increasing numbers of manufacturer complaints that the rising currency is hurting their overseas shipping activities.

To view Figure 1 of this press release, please visit the following link:

http://media3.marketwire.com/docs/938420-F1.pdf

Many analysts and economists have been "bearish" on EURUSD due to the divergence in policies between ECB and the Federal Reserve (Fed), when the Fed started to taper its monthly purchases last year. The view seems realistic in the bond market, as the U.S./Germany 10-year spread has been widening since end of January 2014.

To view Figure 2 of this press release, please visit the following link:

http://media3.marketwire.com/docs/938420-F2.pdf

However, the real fundamentals are not so "bearish". The monetary policy cycles of the U.S. and Euro Zone have been diverging since 3Q 2012 if we were to compare the two central banks' balance sheet.

ECB accepted early repayment of long-term refinancing operations (LTRO), thus making its balance sheet continues to shrink. In contrast, the Fed's balance sheet continues to expand, and will continue to expand for the next six months, at least. Looking at the chart below, EURUSD started to rally when divergence emerged in between the two central banks' balance sheets. Based on this approach, it will prompt Mario Draghi to expand its balance sheet immediately if Euro falls.

To view Figure 3 of this press release, please visit the following link:

http://media3.marketwire.com/docs/938420-F3.pdf

ABOUT FXPRIMUS

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