How The Euro Will Respond To The ECB: A Cheat Sheet

With the dollar failing to benefit from yesterday's surprisingly hawkish Fed meeting, traders are confident that the only alternative is for the Euro to surge this morning after the ECB announcement, in which Draghi may (or may not) preannounce the end of QE. In fact, as Bloomberg's Vassilis Karamanis writes in his Cheat Sheet for how the Euro will react this morning, the FX strategist writes that " the euro may gain for the first time in six European Central Bank policy decision days even if President Mario Draghi steers clear of announcing a definite end-date to the institution’s asset-purchase program, trader positioning suggests."

Some more details from his relatively bullish EUR take:

  • Even if the losing streak extends on a dovish slant from Draghi, the euro’s decline may be limited, charts and orderbooks indicate. Conversely, it may take more clarity on interest rates from a hawkish ECB for the euro to breach its mid-May rebound peak
  • Focus on this meeting picked up after ECB Chief Economist Peter Praet signaled that it could be pivotal in deciding an end-date to QE. Option traders agree that this policy decision may be a game changer, at least judging by overnight volatility on the eve of a GC decision
  • The gauge gained as much as ~13 vols Wednesday to touch 20.30%, rising above the previous pre-ECB meeting peak of 20.16%, reached Sept. 6; Wednesday’s level is the highest such reading since December 2016; even with the Fed meeting priced out, one-day vol remains at elevated levels
  • It is not surprising to see a wide breakeven for the euro on the event, given the market is far from unanimous on its outcome; a Bloomberg survey of 56 economists conducted June 1-7 showed a third of respondents predicted Draghi will set an end-date for purchases Thursday
  • Analysts have become more bullish on the euro following recent hawkish comments from ECB officials, even as recent macro data have come on the soft side
  • It is possible that there is a repeat of the Autumn meetings, when Draghi announced updated growth and inflation projections in September and went on with QE-update decisions a month later. Just signaling that a decision on bond purchases was likely in October sent the euro 0.9% higher to 1.2023 on Sept. 7
  • Positioning, according to three traders in London and Europe:
    • Overall, upside risks prevail: short-term names have turned neutral, leaving room for exposure either way; macro and real-money accounts have trimmed their long exposure during the Italian crisis and have yet to re-add in size
    • Interbank desks are only slightly on the long side, if not outright flat
    • Bids at 1.1720-50 and 1.1640-60; offers at 1.1850 and 1.1900-30
    • Market looks long gamma at current levels, could keep ranges relatively tight
  • CFTC data show leveraged investors hold euro shorts at a one-year high, while asset managers are still long the common currency, but off recent record highs
    • DTCC data show a clear preference for euro shorts through vanilla options this week, also due to bets that the Federal Reserve would shift toward a higher dot plot; only a third of trades that went through were betting on a stronger euro
  • The euro is ~2.5% lower since the ECB’s April 26 meeting due to a stronger dollar, with Italy’s political drama also weighing
    • Finding support from the 21-DMA, currently at 1.1727, euro bulls will target 1.1840, the June 11 high; ultimately, 1.1987-96 area, where the 55-DMA and the May 14 high lie, should cap an extended euro rally
    • A dovish-sounding Draghi could see pressure extending below large 1.1700 expiries and toward 1.1617, the June 1 low
  • Sentiment: Traders acknowledge the chance of a bearish surprise by Draghi alongside a hawkish Fed; one-week 25d risk reversals stand at 33bps in favor of euro puts; During the last 12 months, riskies have usually been in favor of euro calls, with the exception of times around elections/political drama in the region

That said, with everyone confident that one thing will happen, i.e. the EUR will spike, don't be surprised to see the EUR tumble...

Finally, here is a big picture market reaction cheat sheet courtesy of ING.