EURUSD (ECB SHOWDOWN)

EUR/USD is awaiting the ECB tomorrow. There is expected to be a dovish tone while participants weigh up the prospects of extended QE from the Central Bank to battle troublesome conditions in the EZ economy. 

Weight is tilted to the downside in the major, and verbal intervention from the ECB might be expected should the price move anywhere close to 1.1500 anyway. 

Meanwhile, the docket is quiet and we will await tomorrow's outcome. For a preview, see here. "If the ECB decides to continue buying €60bn a month, mostly in government bonds, repeating that the program will extend until September 2016, or further if needed, the market will likely be disappointed and will sell the common currency," explained Valeria Bednarik, chief analyst at FXStreet, in her article. 

Technically, key upside comes at 1.1440/72 band (May, June and September highs, the 55 week ma and the 2014-2015 downtrend), and these are leaving the major in a bearish phase. The 1.1260/51 cloud lows are now open for a testing and the September lows at 1.1105/1.1088 could come under pressure.

ECB Preview

"3m Eonia is now trading at the depo rate that sets the bottom of the ECB’s corridor. This means without a rate cut, no further de facto easing from rates can happen.

The lack of downside here is one reason why EURUSD has proven stubbornly supported. 2y2y spreads to the US since the start of the year have moved almost 75bps higher, enough to support 3% upside in EUR.

Central bankers generally believe QE is more effective when conducted with rates at the lower bound. As of January, the ECB thought they were at the lower bound. Other central banks have now shown that is not the case. For example, the Riksbank refi rate, analogous to the ECB’s repo rate is at –35bps while the ECB refi is at +5bps. This suggests the potential for

40bps of interest rate cuts from the ECB. We think they are unlikely to do all that at once, an initial cut of 15- 20bps could see them suggest it is only a technical adjustment to remain at the lower bound and instead focus on them balancing the ECB’s depo rate with the Riksbank’s refi rate. If downside risks to the economy and inflation worsen, that still leaves them with a further 20bps only to equalize with where the Riksbank is right now.

If the ECB waits until December to cut rates (or extend QE) than the staff forecasts have to be more pessimistic as they would incorporate no policy action. Cutting rates now is likely an easier political decision than changing QE, providing better forecasts in December, and buying another six weeks for the GC to see if they really need to change QE."

EUR/USD 2015-10-21T18:00:00