dax potential bullish breakout looms ahead of ecb 1822392016

Daily Outlook, Thurs 21 July 2016

(Click to enlarge charts)

What happened earlier/yesterday

The Germany 30 Index (proxy for the DAX futures) has staged the expected rebound from the predefined short-term pivotal support at 9960/9900 and almost hit the first short-term target/resistance (“Expanding Wedge” range top) at 10180 (printed a high of 10148  yesterday).

The market now waits for the key event of the week, ECB’s monetary policy announcement.

Please click on this link for a recap on our previous daily short-term technical outlook/strategy.

ECB Preview

Majority of economists as per surveyed by the major media outlets are expecting ECB to stand pat on its existing monetary policies (no change in policy interest rates and quantum of current quantitative easing programmes) and more easing will likely be introduced later in the next meeting on 08 September 2016.   The decision on the latest ECB’s monetary policies will be out later at 1145GMT with a press conference chaired by its central banker, Mario Draghi at 1230GMT. In addition, the money markets are now pricing only around a 20% chance that ECB will lower its deposit facility interest rate by 10 bps to -0.50% from -0.40%.

However, do allow me to be the devil’s advocate to argue for a potential easing in today’s ECB monetary policy meeting. My reasons will be as follow:

• Given the ECB minutes from the last 02 June 2016 meeting, policy makers are concerned about the negative repercussions from Brexit and the stressed that they are ready to provide more monetary policy stimulus if inflation continued to miss their desired 2% target. Eurzone inflation has flirted with the 0% level for the past two years with the latest y/y figure for June 2016 (pre-Brexit) that stood at 0.1%.  Leading economic indicator such as  ZEW Eurozone survey on economic sentiment on business activity for July (post Brexit) has deteriorated as it came it below expectations by a wide margin (-14.7 vs. 12.3) . Secondly, another leading indicator, Eurozone consumer confidence flash estimate for July (post Brexit) declined to -7.9 versus a revised figure of -7.2 for June 2016. Therefore, latest readings from these leading economic indicators are likely to increase the risk of deflation, therefore putting pressure on the ECB to ease or tweet its current quantitate easing programmes.
• Given that the recent rush to safe haven assets (European sovereign bonds) that has pushed down the yields of these bonds, the ECB is now facing a lack of supply of government bonds that it can purchased through its existing EUR80bn monthly debt buying plan. Current existing rules only allow ECB to purchase bonds that have yield above the benchmark deposit rate of -0.4% German sovereign bonds form the biggest component due to its relative size of its economy in the Eurozone and more than 60% of German bonds are now yielding less than the -0.4% cut off rate. Thus, it will be a challenge for the ECB to conduct its existing quantitative easing programme in the next few months if the thirst of government bonds continues. In order to address this scarcity issue, ECB may scrap the -0.4% cut off rate but it could expose itself to big losses because the -0.4% cut off rate mirrors the current ECB’s deposit rate charge on banks’ reserves. Alternately, ECB may start to adopt BOJ’s approach in expanding its scope of asset purchases (after investment-grade Euro denominated corporate bonds) which the next in line could be ETFs on European equities that can also potentially drive up the yields on government bonds indirectly due to a reduction in risk aversion behaviour (also it can alleviate the  current scarcity problem without changing the -0.4% cut off rate).

Therefore, if ECB surprises today with its actions, it can reinforce the current positive feedback loop that is on-going in risk assets. Secondly on the currency front, the EUR/USD may tumble below 1.10 which could drive the EUR/GBP down towards the 0.8230 support in the first (please click on this link to recap on our recent technical outlook for EUR/GBP).

Let’s us now focus on the short-term key technical elements on DAX.

Key elements

• Even though, yesterday’s push up in price action has stalled right below the “Expanding Wedge” range top (depicted in pink) at 10180 but the daily RSI oscillator has continued to advocate for a potential bullish breakout of the “Expanding Wedge”. The RSI has already broken above its former descending trendline which is in parallel with the “Expanding Wedge” upper boundary, tested it and staged a rebound from it yesterday (now turns into a pull-back support). All these observations suggest that upside momentum of price action remains intact.
• The key short-term pivotal support now rests at 9930 which is defined by the pull-back support of the former short-term ascending range bullish breakout (depicted in dotted green) and close to the 23.6% Fibonacci retracement of the recent rally from 06 July 2016 low (see 1 hour chart).
• The key short-term resistances now stands at 10340 follow by 10540 (the lower limit of key the 10540/650 zone that is defined by the long-term descending range top/resistance that has capped all the previous advances since April 2015 high and a Fibonacci cluster). A clear break above 10540/650 (weekly close) is likely to indicate that a major low has been formed for the Index on February 2016 and it is on sight for a potential significant recovery.

Key levels (1 to 3 days)

Pivot (key support): 9930

Resistances: 10340 & 10530

Next support: 9800 (medium-term pivot)

Conclusion

Poised for a potential bullish breakout. As long as the 9930 daily short-term pivotal support holds, the Index is likely to see a break above the 10180 “Expand Wedge” top for a further potential upleg to target the next resistances at 10340 and 10530 in the first step.

On the other hand, failure to hold above the 9930 short-term pivotal support is likely to negate the preferred bullish breakout scenario for a deeper pull-back to test the 9800 medium-term pivotal support.

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