Deep dive analysis of the trading execution of AXIA Elite Trader Demetris Mavrommatis over the February 2022 European Central Bank Rate Decision

Trading over Central Bank policy decisions has been a key edge for the AXIA prop trading team and our traders are always prepared for any opportunity arising from a central bank policy shift. Following closely the communication and narrative from central bank speakers is hugely important, as any change in language has the potential to cause market repricing and therefore huge trading opportunities.

On 3rd February 2022, at its monetary policy meeting, the European Central Bank finally jumped on the hawkish bandwagon. After many months of resisting to change its guidance of ultra-low rates even as Eurozone inflation was running above 5%, President Lagarde finally acknowledged upside risks to the Inflation outlook and signalled openness to interest rate hikes in 2022.

AXIA traders, having observed the hawkish pivots from the FED and BOE at the end of last year, were eagerly awaiting such a policy shift from the ECB.

In this article, we will explore how an elite trader executed big short positions in the German and Italian Bonds as Lagarde started dropping the hawkish bombshells that sparked a broad Eurozone bond sell-off.

Watch the live trading execution

In this video, our co-founder and head of Strategy, Alex Haywood, is going through the trading execution of AXIA Elite trader Demetris Mavrommatis, over the ECB Rate Decision on 3 February 2022.

Market Context

Whilst most big central banks including the FED, ECB, and BOC have acknowledged upside risks to Inflation and prepared the markets for rate hikes, the ECB has distanced itself from other central banks by communicating that rise in Eurozone Inflation is only temporary and not a cause of concern.

Although the US and UK Yield curves have flattened aggressively since the FED and BOE turned hawkish in anticipation of rate hikes, the German Yield Curve has remained relatively steeper as ECB maintained its dovish guidance.

Scenario Analysis

There was not much expectation going into the meeting as the vast majority of analysts expected the ECB to reiterate its dovish guidance on rates and QE, and repeat that the recent inflation spike is only temporary and will eventually converge to the 2% target.

The fact that there was not much expectation for any change is what creates an asymmetric risk-reward for traders. In the scenario where the ECB did nothing and reiterated the last meeting’s commentary, then not much reaction is expected in the bond space. 

On the other hand, any change in the ECB’s Risk Assessment, whereby the ECB acknowledges upside risks to the Inflation outlook and signals its readiness to take action has the potential to create a powerful market reaction as this is not priced in by the markets. In such a scenario, we expect a broad Eurozone bond sell-off led by the short-end of the German curve as traders will start pricing in rate hikes. Peripheral bonds that have benefited the most from loose ECB policy will also get hit hard, as Core vs Peripheral spreads are expected to widen

Trading Execution over ECB Press Conference

As expected, the 12.45pm ECB Policy Statement did not contain any significant changes from the previous meeting so there was no trading opportunity there. Attention turns to the 1.30pm ECB Press Conference where Lagarde is expected to expand on the ECB’s deliberations and explain their assessment in detail. 

Lagarde starts her press conference by making upbeat comments on Inflation and the bond markets are on the move. At this point, she is just commenting on the Inflation readings from last month stressing how price rises have become more widespread, however, there is still no explicit comment on the Governing Council’s views on the medium-term inflation outlook. AXIA elite trader Demetris Mavrommatis starts positioning short in the Bund (German 10-year) and the Bobl (German 5-year) but with relatively small size at this point.

1. “Risks to Inflation outlook tilted to the upside“

Lagarde moves on to ECB’s Risk Assessment. This is a key paragraph in the ECB Statement where Lagarde comments on the risks to the economic outlook and Inflation outlook. Although the risks to the economic outlook are “broadly balanced” over the medium term, the risks to the inflation outlook are now “tilted to the upside”. Lagarde drops the first inflation bomb.

Compared with our expectations in December, risks to the inflation outlook are tilted to the upside

ECB President Christine Lagarde (3 February 2022)

This is the first time the ECB has explicitly stated that the risks to the inflation outlook are tilted to the upside and this commentary sends a hawkish signal to the markets. The ECB’s mandate is to achieve price stability by aiming for 2% inflation over the medium term. A view that risks are now to the upside means that the ECB will pay very close attention to inflation and potentially act to control it by raising rates. This is the first trigger point of execution. As soon as Lagarde says this, Demetris executes big short positions of over 1300 lots in Bund, Bobl and BTP. 

2. “Unanimous concern on Inflation numbers“

Although there was an initial spike lower in the bonds after the first hawkish comment from Lagarde, the markets quickly stalled and the focus is now on the upcoming Q&A. The key is to see how the ECB is prepared to respond to the upside inflation risks and whether they are ready to stop the QE and begin raising rates this year. Q&A will be critical in order to gauge ECB’s reaction function to the upside inflation risks. Lagarde starts answering the first question by saying:

I can tell you there was unanimous concern around the table of the governing council about inflation numbers

ECB President Christine Lagarde (3 February 2022)

This is the second trigger point that adds to Demetris’ conviction. Expressing concern shows that the ECB is growing uncomfortable with the high inflation readings, and it’s a signal of its willingness to act to control Inflation. This comment sparks another wave of sell-off in Eurozone bonds as Demetris Mavrommatis adds to his short positions. Short-end of the German curve (Schatz/Bobl) and peripheral bonds (BTP) underperform.

3. Leaving the door open for 2022 rate hikes

As the sell-off in the bonds accelerates, Lagarde is asked to comment on whether she is open to rate hikes in 2022. Unlike the previous meeting where she explicitly stated that a rate hike in 2022 is highly unlikely, this time she refuses to rule out a hike in 2022. This is the third trigger point in execution.

By declining to repeat that a rate increase in 2022 is unlikely, Lagarde officially opens the door to rate hikes. The short-end of the curve, led by the 2-year (Schatz) takes a very big hit as traders start to aggressively price in rate hikes this year. Bobl, Bund, and BTP follow while EUR/USD rallies.

Demetris rebuilds a big short position in the Bonds while buying the Euro. As the moves continue to accelerate as markets are digesting the unexpected ECB Hawkish pivot, he starts exiting his positions achieving a multiple 6-figure P&L

Key takeaways and summary

This article takes a deep-dive analysis of how our elite trader Demetris Mavrommatis executed big positions on the most recent ECB hawkish pivot. We go through the market context, and scenario analysis, but most importantly we closely analyse the key trigger points in Lagarde’s press conference where he executed his biggest size in order to achieve a multiple 6-figure P&L.

Such a policy shift from a major central bank does not happen often, and when it does, it presents a very unique trading opportunity for day traders. 

At AXIA, we train our traders to be prepared for these kinds of events and use clues from other central banks to identify asymmetric high risk-reward trading opportunities. At the end of last year, we were preparing our trainee traders on our 12-month coaching programme to be ready for this in 2022.

A deep understanding of yield curve dynamics is impeccable for traders to understand the relationship between bonds and global markets in an inflationary driven environment, and how to execute most efficiently in such types of events.

To see more examples of Demetris Mavrommatis’s execution on other big fundamental events such as geopolitical events and other central bank policy meetings, visit the AXIA Elite Trader playlist on our YouTube channel.

And for those who seek deeper understanding, we analyse many more of these elite execution videos in our internal training, both on our Career Programme and on our Blueprint Coaching Programme. To register your interest in free training and see more of these, visit www.globalmacrodaytrader.com

FREE Webinar Sign Up: https://www.globalmacrodaytrader.com

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Contacts:
Demetris Mavrommatis — Co-Founder, Head of Trading
Alex Haywood — Co-Founder Head of Strategy

Why Does ‘Substantial Progress’ Matter?

The reference to substantial progress was brought into the Federal Reserve’s statement last month as a qualifier for how long how long their assets purchases would run for and consequently the achievement of substantial progress will initiate the taper process.

“Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals”

The 2 key questions therefore are:

1. How will we know when substantial progress has been made?
2. Once substantial progress has been made how soon after will asset purchases be tapered?

How to Trade Substantial Progress?

Substantial Progress is the focal point for this decision and as with every Central Bank decision one needs to have a process for trading the focal point and other potential change. If we break up a typical central bank decision into it component features many follow a similar pattern of release and the way to trade each part of the release differs. The components are:

• Policy changes – typically a press release of decisions taken and any changes to policy or repeat of the current policy
• Statement – further explanation of reasoning behind policy decisions – guidance on futures potential changes
• Q&A – a chance to find out more information – also chance for the Central Bank to hint further without explicitly committing to a change by putting it in the statement

With expectations low of any change in policy or statement you need a process to quickly ascertain the meaning of a question’s answer and how this will affect markets. So, simplify the what the answer relates to – questions about progress ultimately are trying to answer a simple question – when will taper start? Market expectations are that taper will not begin this year – Powell made this clear in a recent speech (key points are highlighted below). Any suggestion that Substantial Progress could be made/achieved this year should bring forward expectation of taper provides a trade opportunity.

Which Markets to Trade on The Federal Reserve Decision?

Market selection is always key on a Central Bank decision and picking a market that will not only be affected by the change or hint in policy but has the scope to more technically is key – this is why a market may over react in one direction but under achieve expectations for a move in another. So market selection is down to deciding whether a certain market will move better on a hawkish (less stimulus) or dovish (more stimulus) comment. Take for example T-Note (below) this is just one of many potential markets to trade – your preparation needs to consider how it could trade on a move down back against the recent steady move higher (potential sweep of range 137’02-136’21-17) and how will it react at key resistance 137’20? What happens if it break 137’20

Plan Your Trade – Trade Your Plan

Whenever you trade a Central Bank decision and when you are learning to trade Central Banks the most important thing is to have a clear plan of what you are looking for and what you will trade if one of your scenarios plays out. Without this you will be left jumping between markets over the decision and perhaps worse, not being able to see where you went wrong because you have no plan to compare your actions to. Every Central Bank decision can potentially be a chance to make substantial progress in you own, not just form a P+L point of few but from a leaning one too.

Richard

What Did The ECB Do Last Time?

In line with expectations the ECB took a number of decisions including increasing their Pandemic Emergency Purchase Programme (PEPP) by €500 billion to a total of €1,850 billion and extending its duration to March 2022. Extending the duration (to June 2022) and reducing the pricing of TLTROs (to -100bp). At same time they brought in additional minor changes: 4 more PELTROs and and extension of their swap lines until March 2022.

However, markets were still disappointed; for 2 main reasons: a small expectation that the Asset Purchase Programme could be increased from €20 billion to €40 billion was not fulfilled and perhaps more significantly confirmation that the entire PEPP envelope may not need to be used stating: “If favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full.”

So What Can The ECB Do?

To decide where trading opportunities may be and what the ECB can do, one needs to pay attention to the inter-meeting guidance and importantly ECB sources – these are unnamed sources that will ‘leak’ information to the press. Whether intended or not, they serve to set the tone of expectation for upcoming meetings and consequently trade opportunities. Even during the blackout period where Governing Council Members are prohibited from talking about monetary prior to the meeting sources still abound. On 20th January 2021 this headline appeared on Bloomberg:

As a trader your job is to discern where the trade opportunity is in the story – in this case the suggestion is that the ECB is using its PEPP to buy certain countries bonds in greater proportions than others in order to narrow or maintain spreads between EU economies. As this information is now in the public domain but not yet confirmed or denied by the ECB, Christine Lagarde may well face questions on whether the ECB is doing this. So where is the trade? First we need to understand what has been happening which can be illustrated by the yield curves below: Each dot along a line shows the yield on bonds of different duration from 1 month to 30 years. The top 2 curves are Italy – green was at the height of the pandemic (11th March) and Blue is current – yields have fallen. At the same time the purple German curve from 11th March has moved up to the Orange current curve showing yields have risen. The spread (distance between the 2 curves has narrowed).

So the trade depends on Lagarde’s answer – a confirmation of what may be termed spread control (not the same as Yield Curve Control) suggest that the spread may continue to narrow – implying a trade of buying BTP and selling Bund. Conversely any denial or reiteration of the policy guidance that “flexibility of purchases over time, across asset classes and among jurisdictions will continue to support the smooth transmission of monetary policy” could widen the spread in the short term.

Process to Create Trade Opportunities

As illustrated above a process to compare expectations to current market data and conditions is crucial to developing trading ideas and strategies. From and expectation, the first task is to decided which market(s) will be most affected by a change to that expectation. Second, consider the potential outcomes – what would be bullish/bearish unchanged for that market. Third, assess where the trade can be executed and how far any move could go (this can be done by reviewing previous decisions). Fourth, as discussed in last month’s ECB blog priortise which change is going to be the most significant. Finally execute according to your plan – if you haven’t planned for the result that comes you don’t have to trade something you don’t understand or can’t quantify.

 If you want to learn more about how plans can be formulated, check out our Central Banks Trading Strategies Course. For more information on how to develop your trading career, check out our range of Trader ​Training courses and our flagship 6 Week Career Programme which can be attended live on our London Trading Floor or virtually from home as an online trading course.

Richard

The Federal Reserve has to answer that question – as traders we have to answer the question of what will the Fed do if circumstances have shifted and how will we trade the change in policy

What has Changed For the Federal Reserve?

Since 4th November a lot has changed.

1. A vaccine is now available and starting to be rolled out – a positive development which should see the economy able to get back no track
2. Generally data has continued to improve – unemployment rate has fallen further to 6.7% – below the Fed’s own estimate of 7.6% by year end from the September meeting
3. A stimulus program, so often called by the Fed has still not quite got over the line and this is having an impact on house spending and they are beginning to run out of savings
4. Covid cases have begun to surge putting pressure on the economy in the form of lock-downs and business closures
5. Non-farm payrolls missed estimates 245,000 vs the expected 469,000 jobs created and Jobless Claims have risen suddenly to 853,000
6. Yield curve is steepening – meaning borrowing costs for consumers which are tied to longer end rates are getting more expensive

The Fed has to balance the longer term positive of falling unemployment and a vaccine again the immediate risks of sharply rising cases, jobless claims and no fiscal stimulus help. Without the vaccine their decision might have been much easier

What Can The Federal Reserve Do?

Their QE program is where the Fed can have an impact with much of the expectation relating to how they can guide on future changes to the program in order to “sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.” Currently the Fed buys $120bn worth of treasuries and MBS but there is no sense of how long they will sustain this with some expectations of a tapering (reduction of purchases) beginning in H2 2021 particularly no with the vaccine being rolled out.

Asset Purchase Guidance

One option available to the Fed would be to link the asset purchases to a data point or their inflation target and maximum employment, as this is already how they guide on interest rates the implication is that QE will not be tapered until 2023 before a rate rise in 2024. This would be seen as dovish and save the need for the Fed to increase it purchases when the impact of a increase may not be felt until the economy is already improving in Q1 2021

Yield Curve Control or Twist

Yield curve control or operation twist would serve the purpose of reducing borrowing costs for the households. As can be seen below are the yield curves after the July, September, November meeting and the Current curve (orange) progressive rising. Yield curve control would put an explicit cap on rates of a certain maturity so effectively see the Fed buying more, say 10 year bonds as yields approach their cap. Currently 10 year yields are ~0.95% a cap below this will create immediate buying until yields reach the capped level. Operation twist will have a similar effective on more buying in longer dated bonds but without an explicit target, the Fed has experience with this having done so in September 2011

Be Ready to Trade the Outlier

Always a good thing to have visualised before a decision is an outlier – this week it could be the Dots: every quarter each member of the FOMC gives their expectation for where interest rates will be set at the end of the coming 3 years. The 17 Dots guide expectations of when a lift of from the lower bound will come – the light blue dots indicate the median expectation. 4 member expect ‘lift-off’ in 2023 if 5 other members join them this brings forward rate hike and also tapering expectations – whilst a huge outlier it is always worth being prepared for something very few other will be

As always. Make sure you have a plan to trade any central bank event and if you want to learn more about how plans can be formulated, check out our Central Banks Trading Strategies Course. For more information on how to develop your trading career, check out our range of Trader ​Training courses and our flagship 8 Week Career Programme which can be attended live on our London Trading Floor or virtually from home as an online trading course.

Richard

“committees, staff members are already at work in order to do this recalibration exercise, and this recalibration exercise will touch on all our instruments. It is not going to be one or the other. It is not going to be looking at one single instrument. It will be looking at all our instruments”

The question this week, then, is not what can they do? but how much will they change and does the market think it is enough

Trading Lessons From History

The wide range of options available to the ECB makes this decision similar to the decision of June 2020 where again the question was not if, but how much action would be taken? It also follows a common ECB template of setting up action and then taking action at the next meeting a la July 2019 set up and September 2019 following the the July. So what Trading Lessons can we take from these decisions?

ECB Trading Lessons: September 2019

Priortise expectations are and absorb the information: The September 2019 ECB decision was a great example of this – expectations were broad and varied – including Asset Purchase Program (APP) €30b/month for 12 months, rate cuts of 15bps, introduction of tiering, possible adjustment of issuer limits from 33%-50% and change of guide on rates/APP. The most important thing here being size and duration of APP, which on the initial reading the ECB disappointed on with €20bn/month causing a dip in bonds (BTP and Bund) however when read fully there was no end date making this a much larger APP and therefore a buy for bonds causing a very strong reversal following a volatility halt in Bund which caught traders selling on the ‘lower’ €20bn/month

ECB Trading Lessons: June 2020 and October 2020

Which markets will react best: In June this year multiple options were available to the ECB, the focus of which was the Pandemic Emergency Purchase Program being increased by €500bn and extended to June 2021, second to that was whether the ECB could deviate from its capital key. It did both and increased PEPP by €600bn producing a a strong reaction in Stoxx, BTP and Euro but a more muted reaction in Bund which would not benefit so much from a capital key change.

A similar strong reaction was seen to the October 2020 “recalibration” commitment when it was enforced during the first question after the statement causing a rally in both Stoxx and Bund – the main lesson to be taken from both these decisions is that equity markets have reacted well recently to any increase in stimulus so perhaps give the greater conviction trade particularly as now both Stoxx and Dax have February highs in their sights

Trading Opportunities For December ECB

The key to the December meeting is distinguishing between consensus expectations and what some are looking for – potential change. First up the consensus:

• Increase PEPP €500bn to €1850bn and extend duration to End 2021 from June 2021
• Discounted rate on TLTRO extended to or past End 2021

The significant change that can come here is to the size of the PEPP increase, duration doesn’t matter so much because PEPP is a total number so the duration only alters the amount bought per month, rather than imply a larger amount of purchases as in APP. A more subtle change would be dropping the reference to using the the entire PEPP envelope which could be seen as hawkish as its full power will not be deployed. As learnt above equities could be the focal point for PEPP change. Other potential changes include:

• Increasing Tiering which had been a possibilty in July, and September – this would be beneficial banks and therefore equity markets
• APP increase from €20bn to €40bn per month – this could be the biggest surprise but its impact will be in respect to whether PEPP is increased or not:
  • Increased PEPP and APP will be a big boost in stimulus and likely boost equities and BTP
  • No change in PEPP and increased APP could be another example of September 2019 where the initial move on PEPP could be taken back as the rest of the information is absorbed
• Adjustments to TLTROs have historically been limited in their impact on the day along with the other potential changes to re-investments being extended and rules for Fallen Angels (countries who’s credit rating makes them ineligible for bond purchases) all of which will be peripheral to the main question around how much stimulus will be adjusted by.

Use the trading lessons learnt from previous decisions – make sure you have a clear plan as to what you will be trading, priortise the importance of the information coming out and absorb all information when there are multiple moving parts. For more on how to prepare and trade Central Bank Decisions check out the first Central Bank Trading Course in the World

Richard

Why Might The ECB Change Its Monetary Policy?

There are 2 main reasons for changing policy: Disappointing data, particularly inflation, and the potential impact of the Covid-19 second wave. Inflation has taken a downturn in recent months and is now just under the ECB’s projection from September (0.3%) at 0.2% as the ECB has long struggled to get inflation to their target of “close to but below 2%” the recent drop, even though a result of the pandemic, could be a reason act sooner rather than later.

Lock-downs are beginning again across Europe to combat the recent surge in cases with France and Germany announcing further lock-downs of varying severity the day before the ECB decisions. If the economic impact is felt in the same way as in March will be needed. Here the ECB has a balancing act of waiting to see if the EU fiscal response, which is not expected until early next year, can alleviate the issue or whether they will have to preemptively step in with changes to current policy or new measures, Lagarde recently suggested that “options in our toolbox have not been exhausted”

What Are The Expected Changes in Policy?

The ECB has multiple options in how it can change policy, some more dramatic – changing their PEPP program and some more nuanced – changing the tiering multiplier. These potential change are largely expected to be kept until December.

• Increase the PEPP by €500bn from the present €1,350bn level. This would be the most dramatic policy change by increasing money being printed and thereby attempting to avert the problem of falling inflation and preempting the need for more funds in the economy to prevent bank lending seizing up
• Extending the duration of PEPP to end 2021 from June 2021. A more subtle approach that keeps accommodation and ensure the end is far away, a more extreme version could be to not set and end date on PEPP at all as suggested by Villeroy
• Changing some of the criteria in the TLTRO III to make it more attractive to banks to borrow form the ECB – potentially extending the current special rebate until end of year.
• Increasing the tiering multiplier from 6x to perhaps 10 or 12x as was expected back in July. This will help banks profitability but do little to avert the Covid or inflation issues.

ECB Trading Strategy

The ECB rarely changes policy outside of their quarterly meeting, barring exception circumstances, which include staff projection (the last time they did saw PELTROs in April 2020). Therefore signalling the change in policy in December will be the focus, meaning that the statement delivered by Lagarde will where most potential trades lie. Signalling can come in and explicit or implicit form, the expected explicit form of communication would be to use the phrase “task relevant committees” which translates as “we will very likely act at the next meeting.” This phrase was used multiple times by Mario Draghi (in July 2019 before cutting rates and restarting QE the following month) but importantly has not yet been used in a statement by Christine Lagarde. Therefore a different suggestion and variant of “reassessing policy at the next meeting” may well be used instead. The (semi)explicit guidance will send the clearest dovish message, a more subtle approach could be to change language in the opening paragraph of the statement regarding the current situation; the first sentence The incoming data since our last monetary policy meeting in July suggest a strong rebound in activity broadly in line with previous expectations, although the level of activity remains well below the levels prevailing before the coronavirus (COVID-19) pandemic. could be adapted to suggest the rebound is not so strong, thereby implying the need for policy change.

Many of our Axia Traders will be considering the possibility of no change – this is because all the focus seems to be skewed towards some kind of stimulative policy of signalling of one, meaning everyone is looking in the same direction, perhaps a slower burning trade strategy will be need here as throughout the press conference signalling could happen but if no change is coming markets could well be disappointed particularly in light of the recent, Covid induced sell off in equity markets.

As always make sure you have a plan to trade any central bank event and don’t dismiss the importance of no action. If you want to learn more about how plans can be formulated, check out our Central Banks Trading Strategies Course. For more information on how to develop your trading career, check out our range of Trader ​Training courses and our flagship 6 Week Career Programme which can be attended live on our London Trading Floor or virtually from home as an online trading course.

Richard

The Federal Reserve has already shaken markets in recent weeks with Chairman Powell’s speech at Jackson Hole, where a new average inflation target was introduced, as well as a shift to focus on employment over inflation in future in the Fed’s updated Monetary Policy Strategy. As such this meeting, which includes updated Staff Economic Projections (SEPs), will be well watched by all at Axia Futures – looking for possible new forward guidance, what average inflation rate of 2% actually means, whether any of their stimulus programs could be changed and what the impact of the weakening Dollar is having on policy deliberations, if any.

How to Plan Your Federal Reserve Trading Strategy

Going in a Federal Reserve decision without a clear plan and matching trading strategy is like driving a car blind folded – you can operate the controls but have no idea where you are going or what is coming towards you. Firstly work out what the Fed can do/change that would be market moving and then prioritize the importance and impact of each scenario. What can the Fed do? And what is important?

1. Updated SEPs going out to 2023 – the Fed’s Dot Plot which forms part of the SEPs gives a view of every member’s expectation of where interest rates will be at the end of the next 3 years. Below the blue Dots indicate a median expectations of rates remaining at the their present 0-0.25% until end 2022. If the 2023 Dots also indicate no rate change this pushes the next hike into 2024 – a dovish sign. Whereas, if the Blue Dots for 2023 are higher than the current 0-0.25% range then this sends a hawkish message. The 2 Dots in 2022 showing to 2 votes for a rate hike then will also be important – will they join the others or will more members vote for hike?

2. Update Forward Guidance – by linking the end to the current stimulus ($120bn/month of Treasuries and MBS) or Interest Rates to a date or data point the Fed can give clarity to the market that stimulus is staying and will likely to be seen as a dovish change for them. This could be done by changing the current guidance “The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” to include reference to date of data like they did in December 2012 using the statement

“at least as long as the unemployment rate remains above 6½ percent,
inflation over the period between one and two years ahead is projected to be no more than half a percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

3. Average inflation – what does it mean? Rather than being in the statement, this is likely to be a question for Powell following his Jackson Hole speech. Monetary Policy Strategy was updated to include this reference and was taken very dovishly by the market initially although without further clarity this reaction was quickly taken back particularly in EURUSD, Gold and T-NOtes (see below). The above statement, if brought it could preemptively answer this question by giving both a time horizon and maximum above 2% the Federal Reserve would tolerate before acting

What Market to Trade Over The Federal Reserve Decision?

Once you have your Federal Reserve scenarios outlined and prioritized – above is a not exhaustive list of possible options, although some of the main themes showing in analyst research – then it is time to choose your markets to trade. Here you have 2 options: either stick to one market whatever the outcome or or change depending on what is said. If you are uncomfortable trading multiple markets or moving away from your core market in time of high volatility then option one will suit best – you must be aware that some outcomes may not suit your market though and not provide a trading opportunity, whilst watching other markets move. Option 2 affords a greater chance to ‘get involved’ although this must be balanced against whether the change form the Fed is worth a trade being taken. In picking a market, looking at recent reactions can give guidance – above the reactions on Jackson Hole show strong correlation between Gold, EURUSD and T-Note whilst the S&P 500 doesn’t follow the same pattern. Furthermore, Gold and EURUSD reacted the most in both directions – this would suggest that perhaps the greatest opportunities lie in Gold and EURUSD and each can be expected to move in a similar fashion.

Federal Reserve Trade Execution

The key to execution is to have a clear idea of how you chosen market will react to dovish (more stimulus) or hawkish (less stimulus) and where it can go – i.e. key levels and potential distance. This gives prevents hesitation when you see one of your scenarios come into play and also allows you to carry a trade by knowing where it can get to and leaning on correlation in other markets as can be seen here from one of our Elite News Traders

Methods on how to develop and execute your own Federal Reserve Trading Strategies are taught in detail in both our Central Bank Trading Course and Intensive Career Trading Course.

Best of luck during the Fed’s decision – remember to have a clear plan and if you planned trades aren’t available you don’t need to trade immediately – don’t go in blindfolded – your competitors won’t.

Richard

As with last month, expectations of the European Central Bank (ECB) changing policy at its September meeting are rather limited. Opportunities, however, will still be available to the well prepared traders, the main focal areas of trade strategies now revolve around the recent rally in EURUSD (chart below) and changes in the Federal Reserve’s inflation targeting policy.

European Central Bank Trading Strategies

Often research and analysis prior to any Central Bank decision is more based predicting what they can do; as a day trader your focus needs to be on what will you do in any particular event? and which market would be optimal to trade? This way clear scenarios and trade execution plans can be created. So, what can the ECB do? What are the implications? and what markets are likely to be affected?

Addressing the Euro Strength

The strength in EURUSD can be attributed to the positive reaction to dealing with the Covid crisis in Europe and the Fed indicating a more dovish policy going forward, however this has a negative impact on the competitiveness of Eurozone exporters and also inflation. Whilst the ECB often suggests they do not target the exchange rate, recent comments from Lane suggest it is bothered by them at these levels, leading to expectations Lagarde may try to address the Euro strength. This can be done either by policy change or via verbal intervention, both would be expected to have a similar impact on the Euro exchange rate, however policy change will have impacts on other markets too.

Verbal Intervention: Using similar phrasing in their statement as September 2017: recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability. The implication here is that if the Euro doesn’t fall then policy action could be taken, this potential should be priced in causing a possible Euro fall.

Policy Change: The ECB has options here – none are really expected to be used, all will have impacts on other markets at he same time .

• Signal additional PEPP purchases – €350bn increase is the general expectation by December, an earlier or larger increase should weaken the Euro as well as giving a boost to bonds as this where the purchases will be conducted
• Cut rates – Current 0.0% refinancing rate and -0.5% deposit rate, less return on money should reduce demand for Euro, this could also negatively impact bank stocks as banks depositing money at the ECB will receive the new (negative) deposit rate on their money.
• Increasing the Tiering Multiplier – increasing the Tiering Multiplier from the current 6x alone could signal a rate cut in future, as this gives banks the safety of not reducing profit margins if this were to come. See here for a more detailed explanation of the Tiering Multiplier.

ECB Staff Forecasts

Near term forecasts are subject to great uncertainty so are less significant in signalling any policy change, so focus will be on longer term forecast, 2022 in particular. This will give a clue as to how long the current stimulus measures may last. June forecasts are below a drop in 2022 HICP inflation would indicate longer lasting or more stimulus, whilst an unchanged or higher reading would suggest a faster withdrawal than some expect. This likely be negative for bond markets, especially Italian BTPs as they benefited greatly from the ECB PEPP.

Which Market to Trade on the ECB Decision?

Reactions to recent comments provide great information as to how willing certain markets are react to change. A Bloomberg sources comment suggesting no need for more stimulus, the day before the ECB decision created fast reactions in EURUSD as well as Bund and BTP (charts below), however equities markets were unmoved indicating greater opportunity may lie in trading any change in currency or bond markets.

Whilst structural plays for a continuation of the equity market bounce after a recent sell of may be more viable in the event that the ECB, like last month, remains non-committal and provide the market with nothing more than the current muted expectations

Make sure you have a plan to trade any central bank event, the above ideas should in no way be deemed advice and you should formulate your own plans as to which market to trade in each scenario you create. If you want to learn more about how plans can be formulated, check out our Central Banks Trading Course. For more information on how to develop your trading career, check out our range of Trader ​Training courses and our flagship 8 Week Career Programme which can be attended live on our London Trading Floor or virtually from home as an online trading course.

Central Bank Trading Strategies

It is highly unlikely that many trading strategies will be formulated around a specific change in policy – The Fed, last month, formalised its asset purchases at a total of $120bn per month ($80bn of treasuries and $40bn of MBS) and held rates at 0-0.25% whilst indicating neither of these would be likely to change for some time: The Fed cuts its Dots indicating that not one member of the decision making FOMC (Federal Open Market Committee) saw a change in rates this year or next and only 2 saw an increase by end of 2022. The Fed has now settled into a new normal level of support for the economy after the unprecedented stimulus provided in March illustrated below.

Where Are The Trading Opportunities For This Central Bank Decision?

Most Trading Opportunities are going to fall into the interpretation category – a judgment of what The Fed is signalling through its use of language, or the answers that Chairman Powell gives in his Q&A session half an hour after the decision and statement is released. The main potential area of change is to The Fed’s forward guidance – how they describe their position when it comes to changing rates or QE. Understanding The Fed’s statements and learning how a Central Bank can signal a future decision is critical to this trading opportunity. So what is the current forward guidance?

1. On Rates: “The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.“
2. On QE: “Federal Reserve will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace”

Much talk is around the possibility of linking their guidance on rates to inflation (Core PCE YoY 1.1%) or unemployment (11.1%) or even both; by doing this a stronger signal is given that rates can be held at present levels. The interpretation comes in how they may phrase this new guidance and being able recognise it quickly from the statement – this is the role of ‘statement science,’ learning from past decisions – The Federal Reserve has used data based forward guidance when rates were last at these level post the financial crisis specifically in December 2012 when the suggested: “exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal. Linking any change in their policy directly to unemployment and inflation, the full statement can be found here. A similar use of language will enhance current guidance and come as a surprise to many who are still expecting nothing until at least September and thereby create a trading opportunity. Additional trading opportunities including structural plays which turned out to be the main trading opportunity over ECB are discussed in the Axia Futures Central Bank briefing in our live trading floor stream available to members.

Make sure you have a plan to trade any central bank event and if you want to learn more about how plans can be formulated, check out our Central Banks Trading Strategies Course. For more information on how to develop your trading career, check out our range of Trader ​Training courses and our flagship 8 Week Career Programme which can be attended live on our London Trading Floor or virtually from home as an online trading course.

Richard

The European Central Bank (ECB) is soon to make its latest decision on monetary policy. This will be keenly watched at Axia Futures by the Elite Traders who know how big an opportunity a central bank decision can be, as well as by our students on the Career Trading Course, learning to trade central banks for the first time. While trading opportunities may be limited after the ECB already increased its significant stimulus back in June, the level of preparation for this event will not diminish. Rather, it will be the trading strategies that will change.

Central Bank Trading Strategies

The first and most consistent Central Bank trading opportunity is a scenario based trade: The ECB could change some of its policy and create movement in various markets. So what could they do? And more importantly where is the trade in it?

The majority of research is focused on the possibility of the ECB increasing it’s tiering multiplier. The aim of this is to alleviate the costs to banks of placing money at the ECB and receiving a deposit rate of interest of -0.50% (meaning that it costs them to put money at the ECB). Currently European banks must hold a certain amount of their assets at the the ECB, anything above this and they receive the deposit rate.

With all the extra money created since the outbreak of Covid-19, banks now have more spare cash on hand and will incur costs when depositing it. A tiering multiplier was created in Autumn 2019 and is applied, meaning 6x the required amount can be deposited and a bank will not have to pay the punitive -0.5% interest. The additional stimulus due to Covid-19 now means banks have even more money and are being affected again. Therefore, there are calls for the multiplier to be increased to 10x or 12x.

ECB Trading Scenarios

So where is the trade opportunity? An increase will be good for banks and creates an obvious equity market trade. Your scenarios could be:

1. Increase to 10x or 12x would be in line with expectation and create a potentially short lived move.
2. No increase – because expectations are for an increase, this would be a disappointment and offer a possible short in equities.
3. Larger than 12x would be a significant change and should theoretically keep equity markets moving higher.

Having a clear set of scenarios and a plan as to how you will execute them is one of the most important parts when learning to trade Central Bank announcements. Not only does a clear plan reduce hesitation in your interpretation if one of your scenarios play out, but it also gives you a reference against which to compare your performance to your expectations. Today’s potential scenarios are covered in the Axia Futures Central Bank briefing in our live trading floor stream available to members.

Trading Strategies If The ECB Does Nothing

Bank Trading Strategies are still available even if no policy change occur. Once the no-change decision has passed, markets will then present structural plays: trading strategies based on positioning and where markets indicate they want to go. Markets typically stabilise before a central bank decision as participants wait on the possibility of change before adjusting or taking new positions. As such, pent up volume is ready to act and thereby creates heightened trading opportunities.

Take for example the Dax over the April ECB decisions below – whilst the decision was broadly in line with expectations, there was still a large trading opportunity: Because the market ran higher the day before yet didn’t shift value on the market profile, it can more easily reverse (an elastic band trade), as when nothing indicates a reason to continue higher, the buyers from the previous day need to exit their positions.

Similar trading strategies may well be available today. The important thing is to have a clear idea where your traded market can potentially move and an awareness of how that expectation aligns with many other participants in the market and the moves that can quickly develop and go further than expected.

Makes sure you have a plan to trade any central bank event and if you want to learn more about how plans can be formulated, check out our Central Banks Trading Strategies Course. For more information on how to develop your trading career, check out our range of Trader ​Training courses and our flagship 8 Week Career Programme which can be attended live on our London Trading Floor or virtually from home as an online trading course.

Richard