Gold, stocks surged after ECB cut repo and MRO rate by 60 bps

·         Wall Street, Gold surged on renewed hopes of a 50 bps rate cut by the Fed rather than 25 bps 18th September

·         On Thursday, the ECB cut repo (MLF), interbank (MRO) rates by 60 bps and reverse repo (DRF) by 25 bps as a one-time technical spread adjustment

·         Gold was also boosted by the increasing WW-III narrative by Putin and Trump

On Wednesday Dow Future plunged from around 40700 to almost 40000 after BLS data showed the last mile of US disinflation may have stalled to some extent, which may keep the Fed for an orderly/gradual rate cut of -25 bps each in every quarter end rather than any -50 bps jumbo or even back-t0-back -25 bps rate cuts in every consecutive FOMC meetings. But later, Dow Future also recovered on short covering and value buying coupled with Nvidia boost after a report that the US may allow the company to export high-end AI chips to Saudi Arabia. Also, positive comments about the outlook of the company/AI chip sector by the Nvidia CEP helped the risk on sentiment.

On mid-Friday, Wall Street Futures recovered and surged to close in deep to moderate green. Gold stumbled from around 2530 to 2500 and then recovered to close around 2515; the progress of the Gaza war ceasefire is also undercutting gold, while some random news of the Russia-Ukraine war also boosted it sometimes briefly. USD, US bond yield surged on fading hopes of jumbo Fed rate cuts. Oil surged on US inventory drawdown hopes and increasing probability of Harris winning in the US election, who may not encourage US fracking (oil production) like Trump.

Also, Harris's victory may be good for Wall Street as there will be no Trump trade tantrum and policy continuity. And unlike Trump, Democrats led by Harris may also be good for Gold as Russia-Ukraine and even the Gaza war may be dragged on; i.e. we may continue to see lingering geopolitical tensions. Also, the US may have a higher fiscal deficit under Democrats for not only housing/infra-related fiscal stimulus, but also for Ukraine and Gaza war funding. Gold is a major beneficiary of 3D (deficit, debt and currency devaluation).

On Thursday (13th Sep’24), the ECB cut the policy deposit rate facility (DRF-reverse repo rate) by -25 bps to +3.50%, marginal lending facility (MLF-repo rate) by -60 bps to +3.90% and interbank rate (interest rate on main refinancing operations-MRO) also by -60 bps to +3.65% as highly expected. In the process, ECB has reduced the spread between repo and reverse repo rate (MLF-DRF) to +40 bps (3.90-3.50%) from earlier +75 bps (4.50-3.75%) and also between interbank rate and reverse repo rate (MRO-DRF) to +15 bps (3.65-3.50) from earlier +50 bps (4.25-3.75%).

Fed’s spread is +10 bps (repo-reverse repo rate) and -7 bps (interbank-reverse repo rate) against ECB’s +75 bps and +50 bps earlier. ECB now has +40 bps (repo-reverse repo rate) and +15 bps (interbank-reverse repo rate). The normal spread between repo and reverse repo rates for most other global central banks is +25 bps.

When banks earn a higher spread between repo and reverse repo rates or between interbank and reverse repo rates, they tend to deploy more funds in lending operations (direct to borrowers or other banks) rather than depositing the same with the central bank to earn a lower risk-free return. As the ECB reduced these spreads despite cutting rates drastically (as it seems) by -60 bps for repo and interbank rates along with an orderly -25 bps for reverse repo rate, it may discourage banks from lending more rather than deploying the excess fund with ECB to earn a risk-free return.

Thus despite cutting repo and interbank lending rates big by -60 bps, the overall stance of the ECB is less dovish; i.e. it’s a dovish cut by the ECB. As usual, after the ECB meeting, ECB sources almost confirmed that the ECB may cut next in Dec’24 (QTR end) unless there are some exigencies (worst economic data) ahead of the October meeting. Thus EURUSD got some boost Thursday, affecting the dollar index and also boosting Gold to some extent in the process.

In Dec’24, the ECB may further cut all rates (MLF, DRF and MRO) by -25 bps for the same spread as in Sep’24. Central banks generally target overnight interbank rates (like SOFR for Fed) to align with the official fixed reverse repo rate, so that the interbank funding market runs smoothly and all banks lend to each other for their funding requirement rather than lending from the central bank repo window, which is the last resort for financial stability, especially during QT.

Fed’s SOFR (Secured Overnight Lending Rate) is now around +5.33% against a reverse repo rate of +5.40% and repo rate of +5.50%. During late 2019, even before COVID, there was a brief repo (funding) market crisis due to excessive QT by the Fed (compared to the demand for liquidity) and SOFR jumped to an even +5.40% against the then reverse repo rate of +2.15% and repo rate +2.25% when Fed was trying to normalize through QT and rate hikes. This led to a Fed mini QE even before COVID; after COVID, the Fed introduced ON-RRP to manage banking liquidity in both directions (injections or absorptions) to prevent such a repo market crisis.

In the longer run, when such an interbank rate comes closer to the reverse repo rate, the cost of funds for banks also comes lower, which may also push down bond yields and overall cost of borrowing for not only banks but also its borrowing clients.

·         wiOn 13th Mar’24, the ECB formally notified about Changes to the operational framework for implementing monetary policy: Key points.

·         Governing Council to continue to steer monetary policy stance by adjusting deposit facility rate (DFR)

·         Liquidity to be provided through a broad mix of instruments

·         Main refinancing operations (MROs) play a central role in meeting banks’ liquidity needs and continue to be conducted through fixed-rate tenders with full allotment against broad collateral

·         Spread between the rate on MROs and DFR to be reduced to +15 bps as of 18th September 2024 (from +50 bps prior/earlier)

·         Review of key framework parameters foreseen in 2026, based on experience gained in the intervening period, or earlier if necessary

·         These changes will affect how central bank liquidity will be provided as excess liquidity in the banking system, while remaining significant over the coming years, gradually declines

·         The purpose of the operational framework is to steer short-term money market rates closely in line with the Governing Council’s monetary policy decisions

·         The review of the operational framework was announced in December 2022 to ensure that it remains appropriate as the Eurosystem balance sheet normalizes

·         The Governing Council agreed on a set of principles that will guide monetary policy implementation in the future

·         This is best achieved by steering short-term money market rates closely in line with monetary policy decisions

·         Some volatility in money market rates can be tolerated as long as it does not blur the signal about the intended monetary policy stance

·         The Governing Council will continue to steer the monetary policy stance through the DFR. Short-term money market interest rates are expected to evolve in the vicinity of the DFR with tolerance for some volatility as long as it does not blur the signal about the intended monetary policy stance

·         The three-month LTROs will also continue to be conducted through fixed-rate tender procedures with full allotment

·         The rate on the MROs will be adjusted such that the spread between the rate on the MROs and the DFR will be reduced to 15 basis points from the current spread of 50 basis points

·         This narrower spread will incentivize bidding in the weekly operations, so that short-term money market rates are likely to evolve in the vicinity of the DFR, and it will limit the potential scope for volatility in short-term money market rates

·         At the same time, it will leave room for money market activity and provide incentives for banks to seek market-based funding solutions

·         The rate on the marginal lending facility (MLF) will also be adjusted such that the spread between the rate on the MLF and the rate on the MROs will remain unchanged at 25 basis points

·         These operations will make a substantial contribution to covering the banking sector’s structural liquidity needs arising from autonomous factors and minimum reserve requirements

·         The structural refinancing operations and the structural portfolio of securities will be calibrated in accordance with the above principles and to avoid interference with the monetary policy stance

·         In line with its monetary policy decisions, the Governing Council expects the portfolios acquired under the asset purchase program (APP) and the pandemic emergency purchase program (PEPP) to continue to be run off (QT)

·         The reserve ratio for determining banks’ minimum reserve requirements remains unchanged at 1%. The remuneration of minimum reserves remains unchanged at 0%

Conclusions:

Overall, the ECB has already clarified back in mid-March’24 that it will change the spread between its key policy rates in Sep’24 policy, so that the effective short-term interbank rate (MRO) aligns with the underlying reverse repo (DFR) and repo (MLF) rate:

·         MRO-DFR rate spread now +15 bps vs earlier +50 bps

·         MLF-MRO rate spread remains at +25 bps vs earlier +25 bps

Thus going forward, in Dec’24 ECB mat continue to cut its three key policy rates (MLF, DRF, and MRO) by -25 bps (in line with Fed) at each QTR end like it did in June and Sep’24 for the next two years (2025-26) to maintain the above spread until at least 2026.

 Bottom line:

ECB has done a one-time technical adjustment in all its three key policy rates as announced on 13th Mar’24 and also in line with market expectations. Thus overall positive impact on EURUSD and EU/German bonds was quite limited as going forward, the ECB will also gradually cut rates in line with the Fed’s -25 bps, not any jumbo rate cuts for repo rate (MLF) and interbank rate (MRO).

Market Impact:

On Thursday, EURUSD got some boost on a less dovish hike by the ECB, while Gold, and Wall Street Futures also jumped on renewed hopes of a jumbo Fed rate cut after the ECB cut its repo (MLF) rate by -60 bps against reverse repo (DFR) rate by normal -25 bps. Gold also got a boost on increasing the WW-III narrative by Putin and Trump, alleging US/NATO/West is playing fire with the WW-III/Nuclear war!

On Thursday, Gold also jumped after Putin said: “The use of Western high-precision long-range weapons against Russia will mean direct participation of NATO countries in military operations in Ukraine”.

On Thursday, Wall Street Futures were also undercut by than expected US PPI report, which along with the CPI report indicated US core PCE inflation may have stalled again or even ticked up in Aug’24 and thus Fed will cut by normal -25 bps each QTR end rather than some jumbo rate cuts (-50 bps) or even back-to-back -25 bps. But some market participants and financial journalists (led by WSJ) may be still expecting the Fed will start the next rate cut cycle by going for -50 bps jumbo rate cuts not only in Sep’24 but also in Dec’24, totaling -100 bps. This is creating some uncertainty and volatility in the market, but this is always welcome for a vibrant financial market!

On Thursday, DJ-30 surged +0.58%; SPX-500 gained +0.75%, while NQ-100 jumped +1.00%. Wall Street was boosted by communication services, consumer discretionary, energy, materials, techs, industrials, consumer staples, healthcare, utilities, banks & financials, and real estate to some extent. Scrip-wise, Wall Street was boosted by Nvidia, Broadcom, Meta, Amazon, Alphabet, Salesforce, 3M, Caterpillar, Boeing, IBM, and Apple, while dragged by Intel, JPM, P&G, and United Health.

Weekly-Technical trading levels: DJ-30, NQ-100, SPX-500, Gold and EURUSD:

Whatever the narrative, technically Dow Future (40970) has to sustain over 41300-41500 for any further rally to 41650/41750*-41950/42100* and 42700/41900-43050/44250-44500/44800 in the coming days; otherwise sustaining below 41200-41000, DJ-30 may again fall to 41900/40700-40500*/40300 and 40150/40000*-39700/39450 and further 39350/39200-39100/38900 and 38500*/38300-38000/37600 in the coming days.

Similarly, NQ-100 Future (18650) has to sustain over 18900/19000-19200/19500 for further recovery and rally to 19800/20050-20200/20300 for any further rally to 20400*/20600-20800/21050* and further to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 18750-18650, NQ-100 may again fall to 18400/18200-17950/17600 and 17450-17300/17000 in the coming days.

Technically, SPX-500 (5475), now has to sustain over 5550 for any further rally to 5575/5675 and 5725/5750*-5850*/5900 and 6000/6050 and 6100/6150 in the coming days; otherwise, sustaining below 5550-5500 may again fall to 5450/5390-5370/5300* and 5250/5100* and further 5050/4950*-4850/4750 and 4550/4450-4350*/3850 in the coming days.

Also, technically Gold (XAU/USD: 2500) has to sustain over 2510 for a further rally to 2520/2530-2540* and 2560/2575*-2600/2650 in the coming days; otherwise sustaining below 2505, may fall to 2490/2480-2460/2445* and 2435/2420-2410/2400 and further to 2375/2350*-2325/2300 in the coming days.

Whatever the narrative, technically EURUSD (1.11000) now has to sustain above 1.11300 for any further Rally to 1.11500*/1.11800-1.12500/1.13000* and even 1.14500-1.17400 in the coming days; otherwise sustaining below 1.11200-1.11000, may again fall to 1.10500/1.10000-1.09500/1.09000 and further to 1.08600/1.07900-1.07700/1.06700 and 1.06000/1.05300/1.05000* in the coming days; present normal trading range: 1.12300-1.10000-1.08200.ng clients.