Mario Draghi shocked the market by giving it exactly what it wanted. The ECB tapered the monthly amount of bond buying from EUR80b to EUR60B, but extended the duration of the purchases for another nine months. This effectively increased the total amount of QE to EUR540b. Critically the ECB made two other dovish moves; first it increased the amount of bonds it can buy through the inclusion of 1 year maturity notes; second it announced it will buy bonds that yield below the deposit rate of -0.4%. The effect of these decisions will be that short term rates in the Euro-zone will likely fall below the -0.4% deposit rate.
Euro To Break 1.05
The knee jerk reaction was a significantly stronger Euro and weaker dollar – but once the market realized that this was not really a taper, the move was reverse. On the reversal BK re-entered his short Euro, long Dollar position. In BK’s humble opinion, today’s move by the ECB should be enough of a catalyst to push the EURUSD rate below the critical 1.05 level.
The 1.05 level represents both support since 2015 and the convergence with a major trend line that extends back to the inception of the Euro. A break of this level has the potential to lead to a significantly lower Euro. In particular, over the next year parity with the US Dollar would be a good target. In effect this means that the US Dollar Index will climb substantially higher.
Yuan to Weaken Above 7
A substantially weaker Euro will give China cover to weaken the Yuan further, although China will claim it is maintaining a stable Yuan. Recall that China now pegs its currency to a basket called the CFETS, which is weighted away from the US Dollar and toward the Euro – therefore to maintain stability with a weakening Euro the Yuan must also weaken. In “Shrodinger’s Yuan,” BK explained how this peg to a basket of currencies is pure brilliance on the part of the Chinese. In short, China can claim that it is simply maintaining a stable currency, when in reality most shipments are priced in US dollars.
While shorting the Yuan is a virtually impossible trade for non-institutional investors, there is a way to play the coming weakness…buy bitcoin. China has the largest bitcoin trading markets, in fact, bitcoin trades more daily volume in China than the Gold ETF (GLD) trades on a daily basis in the US. Bitcoin is China’s safe-haven asset. Over the last year, the price of bitcoin has lead the Yuan rate by a few weeks to a few months. At current prices, bitcoin is pricing in a USDRMB rate of 6.94 or 1.24% weaker than current spot prices. BK expects that as the Yuan weakens the price of bitcoin will rise and price a further weakening above 7.
Get Ready for Rising Inflation
One might think that a rising dollar would act as a brake on inflationary pressures but one would be wrong. The truth is that a rising dollar and a weakening Yuan means that China is now exporting inflation – this is a marked change from recent history and the market has yet to realize it. Rising commodity prices and wage pressures in China are increasing factory gate prices or PPI. China has suppressed price pressures for as long as it can and now rising PPI will be passed through to the supply chain. This means that everything from iPhones, drones and clothes will become more expensive for US consumers.
If rising prices for consumer goods is coupled with a robust US economy then we may just be in for the good type of inflation. But if PEOTUS’ trillion dollar stimulus doesn’t do the job, then this inflationary impulse could be labeled bad. In either case, the trade is to buy gold and silver. This is exactly the environment where precious metals rise at the same time as the US dollar rises.