While the Australia dollar was the biggest mover today, there’s no doubt that the most volatile currency was the euro. The shared currency tumbled, then rebounded then tumbled again on rumours from the European Central Bank.
- Today’s price action suggests that risks are tilted to the downside ahead of the ECB meeting
- EURUSD is far from its fair value as indicated by the interest rates market and the market is net long euro
- The EURUSD is below an important resistance that is needed to be broken if the pair is to rally further
The first rumour stated that the ECB is set to upgrade its growth forecasts, but at the same time the inflation forecast is to be lowered. That caused a sharp sell-off of the European currency that pushed the EURUSD close to an important level of support at 1.12. However, a rebound occured just after another rumour was published. It was more or less similar to the first one, but underlined an importance of the growth projections upgrade. So what could we expect from the euro tomorrow?
Let’s begin with the economic data. Most figures surprised to the upside since March, which should be euro positive. One should remember, however, that the last inflation print was much weaker than expected and that could be a concern for the euro bulls. Inflation is in the center of the Bank’s focus, so a disappointment in such area could lead to a decision that is less hawkish than expected. Such scenario would be in line with the rumoured changes in forecasts which should be slightly negative for the European currency.
Moving on, the ECB could also change its forward guidance and that’s on what the market will focus during this meeting. The Bank could introduce some changes in its statement. For example, it could say that rates will remain at current level, while until today it has been said that rates will be at current or lower level. The bank could also indicate that the balance of risks has improved. Such move would be the first step towards policy normalization, that is not expected to be announced tomorrow. Draghi’s press conference will be important too. A tone of his words will be crucial for the euro’s reaction. If rumours are true, he will try to be “softly-hawkish” – upbeat on the economic growth, but cautious on inflation.
So how could the euro react? In fact, today’s moves give us an insight of what could happen tomorrow. As CFTC data shows the market is long euro as the currency rose sharply in anticipation of the meeting. Traders expect the central bank to be hawkish, so a neutral or less hawkish outcome could lead to a sharp fall of the shared currency. We’ve seen such scenario a few times before, so it wouldn’t be a big surprise to see an opposite reaction.
The market is net-long euro for the first time in 4 years. That suggests that traders expect the hawkish outcome of tomorrow’s meeting. source: Bloomberg
What’s more, the downside scenario has also its backing in the interest rates market. Looking at the spread between 10yr yields we could notice that the pair should be much lower, closer to 1.0950. If the ECB disappoints, we could see the euro falling towards its fair value as indicated by the interest rates market. In addition, short-term rates suggest that even more downside could be found on the EURUSD.
Interest rates market points that the fair value of the EURUSD is somewhat below 1.10. source: Bloomberg
Moreover, EURUSD has halted its rally close to 1.1300, an important level of resistance. The pair gained almost 9 big figures this year, which makes the euro one of the strongest currencies among G10. EURUSD moves within the long-term upward channel, but a break above 1.13 is needed for the rally to continue. On the other hand, a break below 1.1200 could open more downside, with a break from the channel that could lead to a test of an important support at 1.1050.
EURUSD remains in the long-term upward channel. A break below 1.1200 could lead to a test of 1.1050, while a move above 1.1300 could lead to a quick move towards 1.15.
Conclusion: The ECB will probably change its statement and its approach, but we doubt that such change will be enough to spur another leg higher on the EURUSD. The market is net long euro and the currency is far from its fair value, so a scope for stronger euro is rather limited. Meanwhile, a disappointment could force traders to close their longs, thus leading to a correction on the pair. It’s worth listening to Draghi’s conference and selling the pair if he doesn’t sound as hawkish as expected.