FX Update: ECB meeting the chief focus this week

Trading interest

• Maintaining long AUDNZD position with stops below 1.0570 and targeting 1.0950
• Maintaining short EURSEK, lowering stops to 10.71 and targeting low 10.50’s
• Long EURCHF with stops below 1.0850 for 1.1000+

The ECB meeting is this week’s chief highlight as we all question whether the market has overpriced the scale of the easing package Draghi and company are set to deliver and whether any new easing is pushing on a string anyway. President Draghi is no doubt ready to bring out the big policy bazooka, but there seems a noisier contingent of ECB “hawks” leaning against significant activism. On the way at this Thursday’s meeting is some mix of rate cut (odds only slightly favour 10 vs 20 bp cut), tiering (a must for core banks with the huge reserves paying negative interest), new cheap loans to banks (most important for peripheral banks to continue to roll bad debt) and asset purchases (likely the most controversial topic among ECB governing council given where yields are trading, nonetheless estimates start with EUR 20 billion per month and pick up steeply from there).

The net effect of these measures will bring some degree of relief for the banking system in particular – an absolute must to pull the European financial sector out of its death spiral and avoiding the current policy environment from inflicting active harm on banks and credit transmission. Still, the more powerful medicine for the economy (and the euro) would be coordination with EU governments to link QE with significant fiscal stimulus and perhaps combining this with Bank of Japan-style yield curve control, but it appears too early to look for this. As for the EUR, the single currency is rather weak against risky currencies after last week’s surge in risk appetite, but has pulled back to critical levels against the US dollar, as we look at in the chart below.

The coverage of Brexit and UK Prime Minister Boris Johnson’s political travails and the comeback in sterling don’t take into account that the machinations of parliament to seize control and avoid a “cliff edge” No Deal on October 31, and even the chaos in his the Conservative party could eventually play straight into Johnson's hands in an election scenario, as polls continue to indicate strong outcomes for the Conservatives. In other words, No Deal Brexit odds may be higher than ever beyond a new January deadline and investors looking positioning for “No Deal or Corbyn” now have far better prices and implied volatilities to work with for downside sterling scenarios. This week, Johnson will again look to call for an election, though there could yet be drama around the bill to force a deadline extension.

China fixed USDCNY eleven basis points lower overnight, and it won’t be surprising if USDCNY is closer to 7.05 than 7.15 – or at least kept very quiet – through China’s National Day celebrations at the first of next month and ahead of the US and China talks sometime thereafter.

Chart: EURUSD
EURUSD is at a crossroads this week as we await ECB easing measures and whether the market has overpriced these. The rejection of the recent break below 1.1000 in EURUSD is a hopeful development for bulls, but not yet forceful enough to reverse the trend. The 1.1000-50 area looks pivotal over this week’s ECB meeting and the prior price action in recent months is not encouraging for structural bulls unless the narrative somehow changes, as every rally has eventually faded and long positions are costly to hold because of the carry differential.