ECB monetary policy announcement can bring back the long due FX volatility

By Vatsal Srivastava

There are five central bank meetings next week but the European Central Bank’s monetary policy announcement will be the most important catalyst for the move in the US Dollar Index and the EUR/USD.

In fact, the ECB meeting will even trump the US non-farm payrolls report in terms of its impact on the EUR/USD. Currency Corner does not believe that the ECB is ready to roll out Quantitative Easing just yet, but given recent economic data particularly from Germany, the case for additional stimulus is growing.

FX VolatalityCore Euro-zone CPI growth ticked up in the month of August and this is yet another short term support for Euro longs going into the September 5th meet. While we may see escalated tension and thus downward pressure on the EUR/USD due to the Russian/Ukraine conflict, Russian exports represent only 1 percent of German GDP. It is widely expected that Draghi will reiterate that the problem for Germany and many other countries in the region is restrictive fiscal policy.

The surprise uptick in core CPI growth could make Mario Draghi more comfortable with leaving monetary policy unchanged next week. Further, with the first TLTRO programme expected in September, Currency Corner expects the ECB to wait until its impact is gauged.

The fundamental view on this matter is that the course for the ECB is clear and the only question is how quickly and in what form will they will ease again. It is only a matter of timing and in this columns view, we have maintained September is not the base case scenario for QE initiation.

Note that the EUR/USD will sell off to levels of around 1.3120 if the central bank significantly lowers their GDP and inflation forecasts (their staff forecasts will be released next week). These will be multi month lows in the Euro. Some economists are also calling for a 10bp deposit rate cut which would constitute easing but we think the central bank will postpone this move.

How are currency traders positioned in the EUR/USD? The underlying theme remains sell on rallies but our immediate trade would be to go long around the 1.3150-1.3170 level if enough dovish comments aren’t made. On the charts, the currency pair looks oversold but any move to about 1.3210 is met with selling pressure.

The next major resistance is 1.3250. As seen in the chart below, if we break 1.3126 on the downside, the Euro is exposed to a slide all the way down to 1.3.

The Relative Strength Index (RSI) is currently 24 on the daily charts and we would like to enter yet another relief rally trade to around 1.3220. Any talk of QE plus the 10bp rate cut-which is not priced in yet, we will look to go short. More trading strategies will follow on the EUR/USD as we approach 5th September.

Foreign exchange volatility has been at a multi year low in recent months with G-8 crosses maintaining narrow trading ranges. A steep sell off in the Euro would imply a stronger Dollar Index as even the Yen is all set to weaken due to the adverse effects of the sales tax hike on the Japanese economy.

Even the Bank of England has put the rate hike talk on the backburner and the British Pound has lost ground against the greenback. Finally, the US Dollar is showing strength across the board and this trend is in place till the US Federal Reserve stays on its QE normalizing path.

Expect to see wild moves in the currency market with trading ranges being broken in most major FX crosses if ECB signals QE or cuts its deposit rate.

*Vatsal Srivastava is consulting editor for currencies and commodities with IANS. The views expressed are personal. He can be reached at [email protected]

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