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EUR/USD: Trading the European Central Bank Interest Rate Decision

EUR/USD: Trading the European Central Bank Interest Rate Decision

2010-05-04 14:59:00
Michael Wright;Jonathan Granby,
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Trading the News: European Central Bank Interest Rate Decision

Why Is This Event Important:

The ECB has left rates on hold for a substantial period of time and while speculators begin to hope that a rate hike and the withdrawing of stimulus measures might be on the horizon, the onset of the sovereign debt crisis in the Euro-zone has crippled that hope. Greece, Spain, Portugal and other euro-area members are slashing spending to cut deficits and with growth at risk the ECB will almost certainly keep rates on hold.

What’s Expected:

Time of release:        05/06/2010 11:45 GMT, 7:45 EST
Primary Pair Impact :    EUDUSD
Expected:         1.00%
Previous:         1.00%

Will This Be Market Moving (Scenarios):

The European Central Bank is widely expected to leave rates on hold at 1.00%, and ECB's President Trichet’s press conference will be closely watched for any indication of future hikes and when they may be coming. However, with the euro-area struggling to contain the sovereign debt crisis the comments are likely to be focused on those issues and volatility will remain low.

The Upside

There is little or no chance of a rate hike, however, if President Trichet’s comments indicate that an interest rate hike may be on the horizon this could spur speculative buying of the euro. Any hike is unlikely to come before the second-half of 2010 but the prospect of a narrowing of yield differentials may be enough to increase volatility in the euro. The euro also could get a lift from the reassurance that the ECB is maintaining its very accommodative monetary policy to help stimulate the economy of the euro-zone.

The Downside

If President Trichet’s comments after the rate decision turn out to be less than reassuring regarding both; the future narrowing of yield differentials and the ECB’s accommodative monetary policy we could see the euro posting fresh 2010 lows as market players looks for any reason to sell the currency.

How To Trade This Event Risk


The European Central Bank is widely expected to hold the benchmark interest rate at 1.00% on Thursday as the Greek debt crisis and subsequent downgrades in Spain and Portugal continues to weigh on the euro, and price action following the rate decision may be minimal as ECB President Trichet expects to see an uneven recovery this year. At the same time, growth is likely to sputter in the euro region as governments cut their budget deficits, lowering the longer-term growth prospects for Europe, and thus adding convention that the central bank will keep rates near zero in April.

Statements following the rate decision are likely to stir euro price action, and  if there is any commentary that forecasts a likeliness for a rate hike this year, we will need to see a green, five-minute candle following the rate decision to confirm a buy entry on two-lots of EUR/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance, and this risk will establish our first objective. Our second target will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to lock-in our profits.

On the other hand, subdued price paired with the region’s debt crisis may lead the central bank to hold a cautious outlook for the region, and dovish commentary following the rate decision is likely to weigh on the exchange rate as investors dramatically scale back expectations for a rate hike. As a result, if the Governing council sees scope to keep rates steady throughout the rest of year, we will favor a bearish outlook for the single-currency, and will implement the same strategy for a short euro-dollar trade as the long position laid out above, just vice a versa.

ttn05.04
Impact that the European Central Bank Rate Decision has had on EUR during the Last Month

ttnb

 

The European Central Bank left its key benchmark interest rate unchanged at 1.00% in April as expected , and central bank President, Jean-Claude Trichet said that interest rates are “appropriate,” a signal that policy makers in the region are in no rush to tighten policy as the Greek fiscal crisis delays the exit strategy. Indeed, there is increased speculation that Greece’s woes may spread onto the euro-members such as Portugal, Spain, and Ireland. Meanwhile, Trichet said that the ECB sees “low inflationary pressures over the medium term,” and went onto add that “overall, the governing council expects the euro area economy to grow at a moderate pace in 2010, in an environment of uncertainty with a growth pattern uneven.” Looking ahead, the ECB may continue its “wait and see” approach as Greece may be forced to accept the bailout funds from the IMF and EU.  ttnc

What To Look For Before The Release
Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:
 

Bullish Scenario:

If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the AUD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on AUDUSD ahead of the data release.

00001_EUR
Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the AUD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on AUDUSD ahead of the data release.

00002_EUR
 


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To discuss this report contact David Song, Currency Analyst: instructor@dailyfx.com
 

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