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EURUSD – Looking Past “Taper” Speculation at Fed vs. ECB Policy Trends

By , Currency Strategist  and  Currency Strategist
31 December 2013 18:20 GMT

Talking Points:

  • Fed may look to scale back QE at some point in 2014
  • ECB likely to continue easing monetary policy in the year ahead
  • Will look for technical confirmation to enter short EUR/USD

The markets have been preoccupied with the timeline for the Federal Reserve’s “tapering” of its QE3 asset purchases since the central bank unexpectedly opted to keep the stimulus program at full size in September. While this process is likely to continue feeding short-term volatility, the overall picture is less erratic. On balance, it seems fair to assume the Fed will look to scale back QE at some point in 2014. In relative terms, that represents a hawkish shift along the monetary policy spectrum.

This stands in stark contrast with the trajectory of ECB monetary policy. Eurozone inflation has trended lower for two years, prompting Mario Draghi and company to cut interest rates by 25bps in November after year-on-year CPI slipped to 0.7 percent. This drove the Euro down at first but the single currency quickly erased the drop. This makes sense: cutting the benchmark rate from 50 to 25 basis points means little when the market rate for borrowing Euros (EONIA) has averaged around 8bps this year.

Investors’ inflation expectations priced into bond yields continued to fall after November’s rate cut. Economists agree: a survey of forecasters polled by Bloomberg shows the outlook for 2014 CPI inflation was marked down from 1.5 to 1.3 percent in mid-November, after that month’s ECB meeting. November’s PMI data showed region-wide output prices across the industry spectrum fell for the 20th consecutive month, suggesting calls for lower inflation are rooted in real-economy developments.

EURUSD_Looking_Past_Taper_Speculation_at_Fed_vs_ECB_Policy_Trends_body_Picture_3.png, EURUSD – Looking Past “Taper” Speculation at Fed vs. ECB Policy Trends

All told, this means the ECB is likely to continue easing monetary policy in the year ahead. Non-standard options like negative deposit rates, another round of LTROs or a direct-lending program similar to the BOE’s FLS scheme are possible alternatives. Whichever form said easing takes however, the bottom line remains: the ECB stands to become more dovish while the Fed is positioned to move in the opposite direction, making for a bearish outlook on EUR/USD. I will look for technical confirmation of reversal as prices test channel resistance set from April 2008 to enter short, initially targeting 1.3148 (23.6% Fibonacci expansion level).

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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31 December 2013 18:20 GMT