EUR/USD, EUR/JPY Rates Rebound Off Lows after September ECB Meeting
ECB Meeting Review
- Euro rates saw volatility emerge on Thursday around the September ECB meeting as outgoing President Mario Draghi both disappointed and surprised on the easing front. But to be clear: “Super Mario” did, in fact, make an appearance.
- Even as the ECB embarks on a new QE program, it still holds that the ECB only cut its main rate by 10-bps; the Federal Reserve will be able to outpace the ECB in a rate cut cycle, given that the ECB is already in negative territory.
- The IG Client Sentiment Index isn't sold on a significant rebound by the EUR-crosses, however.
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Euro rates saw volatility emerge on Thursday around the September ECB meeting as outgoing President Mario Draghi both disappointed and surprised on the easing front. But to be clear: “Super Mario” did, in fact, make an appearance. And if traders got the feeling that the European Central Bank is turning Japanese, they may not be wrong.
September ECB Meeting Summary
Here’s a summary of the key decision taken yesterday by the ECB’s Governing Council, the last meeting by outgoing President Mario Draghi at which a new set of Staff Economic Projections (SEP) were produced:
- Interest Rates: 10-bps cut, as expected; open to more rate cuts
- QE: €20 billion/month beginning November 2010; open-ended
- TLTROs: Removal of 10-bps spread over deposit rate
- Deposit Tiering: Japanese model
- Forward Guidance: Rates to “remain at their present or lower levels”; linked to core inflation
On one hand, the lack of a 20-bps rate cut – of which there was nearly a 50% chance of occurring, per overnight index swaps ahead of the September ECB meeting – proved to be a disappointment for some market participants. Similarly, investors were looking for the Swiss model (exemptions as a percentage of minimum reserves) instead of the Japanese model (based on excess reserves).
On the other hand, with forward guidance clear, there is still an overtly dovish tilt to rate pricing (more on that below). The announcement of the QE program was a surprise, as was the change to the TLRO program. It can very much be considered that the “Super Mario” version of ECB President Draghi made an appearance yesterdat.
Eurozone Economic Data Still Disappointing
Now that the ECB is putting its foot back on the monetary pedal, and that forward guidance is explicitly linked to shifts in inflation, investors may see markets become more sensitive to Eurozone economic data in the coming periods.
The ECB’s efforts come when Eurozone economic data is seemingly improving, relatively speaking. The Citi Economic Surprise Index for the Eurozone, a gauge of economic data momentum, is currently at -36.8; one month ago, it was at -52.8.
Eurozone Inflation Expectations versus Brent Oil Prices: Daily Timeframe (September 2018 to September 2019) (Chart 1)
Outgoing ECB President Mario Draghi’s preferred measure of inflation, the 5y5y inflation swap forwards, is currently trading at 1.319%, higher than where they were one week ago at 1.256% and one month earlier at 1.279%, and still significantly above the yearly low set on June 17 at 1.141%. It would appear that the latest efforts by the ECB are provoking a sharp jump in inflation expectations – a sign that the Euro may prove resilient despite the next wave of easing measures.
ECB Rate Cut Cycle Has Only Just Started
Now that the ECB cut interest rates in September – meeting expectations, given that overnight index swaps were discounting a 100% chance of a 10-bps rate cut entering today – investors are quickly shifting their expectations for future policy moves. Given the tone deployed by outgoing ECB President Draghi, particularly around the forward guidance that leaves the door open to more rate cuts, interest rate markets are still pricing in more easing over the coming months.
European Central Bank Interest Rate Expectations (September 12, 2019) (Table 1)
Overnight index swaps are currently pricing in a 62% chance of a 10-bps rate cut at the October ECB meeting. If not, there is a 71% chance of a second 10-bps rate cut coming at the December ECB meeting. But this is the big move: whereas last week rates markets were pricing in three 10-bps rate cuts in September and October 2019 and January 2020; after the September rate cut, rates markets now see the next cuts coming in October 2019 and July 2020.
That the third rate cut has been pushed back by six months may give the Euro some room to breathe in the short-term. But there's another point to consider as well: the ECB has less room to cut rates than the Fed. If the Fed meets expectations and cuts rates by 25-bps at its meeting next week, then the differential between Fed and ECB will rates will have narrowed by net 15-bps during September 2019.
EURUSD TECHNICAL ANALYSIS: DAILY RATE CHART (MAY 2018 TO September 2019) (CHART 2)
In our last EURUSD technical forecast update, it was noted that “the area where EURUSD rates found support is familiar: channel support dating back to the August and November 2018 lows. Similarly, the descending trendline from the January and April 2019 swing highs is proving as support as well…If the EURUSD reversal is going to gather pace, traders may want to see rates breach the August 23 bullish outside engulfing low at 1.1052.”
While EURUSD has been unable to clear out 1.1052 thus far, the support region from last week that produced the yearly low at 1.0926 has held up so far; the low around the September ECB meeting was 1.0927. As a result, we’re now seeing a range form for EURUSD between 1.0926 and 1.1052. The measured target on a bullish reversal attempt higher would be 1.1178.
IG Client Sentiment Index: EURUSD RATE Forecast (September 12, 2019) (Chart 3)
EURUSD: Retail trader data shows 60.3% of traders are net-long with the ratio of traders long to short at 1.52 to 1. In fact, traders have remained net-long since July 1 when EURUSD traded near 1.1369; price has moved 2.7% lower since then. The number of traders net-long is 12.0% lower than yesterday and 18.2% lower from last week, while the number of traders net-short is 15.3% lower than yesterday and 4.7% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EURUSD prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EURUSD-bearish contrarian trading bias.
EURJPY TECHNICAL ANALYSIS: DAILY RATE CHART (SEPTEMBER 2018 TO September 2019) (CHART 4)
In our last EURJPY technical forecast update, it was noted that “the scope of the reversal today speaks to potential for a greater reversal, particularly if the daily 8-, 13-, and 21-EMA envelope is broke to the topside: rates have closed below the daily 21-EMA every session since July 12. With daily MACD and Slow Stochastics starting to turn higher in bearish territory, a move above the daily 21-EMA would suggest a more significant EURJPY bottoming effort is afoot.”
There has been meaningful follow through in the bullish reversal attempt, now that EURJPY has returned above the 61.8% Fibonacci extension at 118.67 (Fibonacci extension of the September 2018 high to January 2019 low to March 2019 high move). EURJPY rates are above the daily 8-, 13-, and 21-EMA envelope which is shifting into bullish sequential order.
Meanwhile, Slow Stochastics has reached overbought territory while daily MACD continues to run higher (albeit in bearish territory). The path of least resistance may be higher at the moment, and if so, a return back to the descending trendline from the 2017 high may be in focus near 120.00.
IG Client Sentiment Index: EURJPY Rate Forecast (September 12, 2019) (Chart 5)
EURJPY: Retail trader data shows 60.4% of traders are net-long with the ratio of traders long to short at 1.53 to 1. In fact, traders have remained net-long since April 25 when EURJPY traded near 125.31; price has moved 4.6% lower since then. The number of traders net-long is 17.0% lower than yesterday and 15.9% lower from last week, while the number of traders net-short is 26.5% lower than yesterday and 10.6% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EURJPY prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EURJPY-bearish contrarian trading bias.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at email@example.com
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