Talking Points:
- The ECB rate decision is due Thursday at 12:45 GMT with the President typically due for his presser 45 minutes later
- There is little chance of a policy change at this meeting, but market participants are already attuned to forward guidance
- Speculation is already running hot behind Euro bulls, and drawing attention to the value gap is the Euro's greatest potential/threat
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What is Likely from the ECB
There is little chance that the European Central Bank (ECB) is planning to change its monetary policy mix of a 0.00 percent benchmark (-0.40 percent deposit rate) and persistent 30 billion QE infusion per month. That said, this is still an event that carries exceptional speculative sway and fundamental nuance to interpret. Key to this event is the context in speculation and the bearings of global monetary policy. Compared to its largest counterparts, the ECB is one of the most dovish major central banks. Its peers range from the Fed who is actively raising rates and reducing its balance sheet to the RBA and RBNZ who are simply biding time until their eventual first rate hike. Despite the week positioning, the Euro however has done remarkably well this past 12 to 14 months.
Short-Term Reaction Versus Medium-Term
For short-term reaction to the ECB's policy decision, there is more likely to be a remarkably reserved response from the Euro. Volatility on this short scale is often dependent on the ability to shock the masses such that there is a mass need to build up or unwind a position. An outcome where rates and stimulus pace remain the same demands none of this capital shift. That said, the medium-term places emphasis on the forecast. Speculative appetite has held remarkably high in both the capital and FX markets which has conferred an unusual value upon the second most liquid currency. There is an appeal for the Euro akin to the US Dollar four years ago. Back in 2014/2015 the Greenback started to rise systemically despite the first rate hike in its now recognizable regime not coming online until December 2015. While the ECB's first move may be well into 2019 - or even later - the markets are bringing forward the speculation they are affording the eventuality. That is an indulgence however that heavily depends on general speculation being set to a remarkably strong bullish setting.
Euro Index Weekly Chart
A Euro That Already Expects Too Much
Heading into the ECB rate decision, my focus will be on the on the general expectations for European yields through the medium-term. We have seen the yield differential between European (German for my spread) and the US 10-year government bonds dropped to create a wide divergence with EUR/USD spot. That has more than a little motivation from the strong speculative view which moves out the focus for rates further out into the future. There is still a lingering speculation for an ECB rate hike sometime in 2019. The central bank has recognized this focus over the past months and ramped up its efforts to curb this speculative fixation. Altering the speculative rank's priorities is extremely unlikely, so the more practical approach is to undermine confidence in even distant rate speculation. The ECB has recently attempted to talk down the Euro with policies such as claiming the US is pursuing a 'weak dollar' position. So far, that has been effective, so more direct and proactive threats may be necessary to render the kind of results they are seeking. One thing is sure, however, the Euro is heavily overvalued at its current level. What can force it to scramble for rebalance?
Keeping a Range of Options
While the Euro has remained stubbornly buoyant in the growing fundamental headwinds, we should not write off the risk/opportunity for a reversal in values. Should the market deem the Euro overvalued against a rising risk aversion and diminished yield forecast, I will be looking to EUR/JPY to solidify its reversal with a break below 134 and 131.50 which can further tap the risk aversion that leads risk aversion. EUR/CAD is another stretched cross prime for correction, while EUR/USD is the most prominent option should it finally clear 1.2200/2100 again. Alternatively, continuation for the Euro, would find a reasonable EUR/GBP and EUR/NZD range to traverse while EUR/JPY can work to fend back a tentative breakdown. We discuss the importance of the ECB rate decision, the interpretations it may draw from speculators and the pairs best primed for the event in today's Strategy Video.
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