ECB meeting: a subtle balance between hawkish and dovish
Today, the main event is obviously the ECB meeting with announcement of the interest rate decision at GMT 11:45 followed by a press conference at GMT 12:30. The question is not whether the European Central Bank will keep interest rates unchanged, nor whether Mario Draghi will announce a reduction of the asset purchase program, but rather the size and timing of the latter. The market is expecting the ECB to trim its monthly purchase by €20bn down to €40bn, while the program should be extended by at least six months (June 2018) if not nine months (September 2018).
Mario Draghi will have the difficult task to announce a hawkish move without triggering a sell-off in the bond market together with a rally of the single currency. Therefore Mario Draghi will give investors what they want: a reduction of the QE; however he will also reiterate his call for cautiousness and remind market participants that the ECB could potentially increase again its support to the economy should the situation require. Such a balanced move would allow the ECB to prevent adverse movements in financial market while moving forward with the QE reduction.
After extending gains yesterday, EUR/USD is trading sideways on Thursday morning at around 1.1825. EUR/CHF printed a new multi-year high yesterday at 1.1705. We think the ECB is not quite happy of the recent sharp appreciation of the euro. Therefore, we anticipate that Draghi will emphasized the subdued inflation pressures together with the risk of a excessively strong EUR to the outlook.
In the short-term, the increase in the price EUR/USD call options compared to put options suggests that the market is positioned for further EUR/USD strength. However, in the longer term, this is a different story as puts are more expensive than calls (6m 25 delta risk reversal is equal to -0.175%), suggesting that investors are rather bearish on the medium-term outlook for EUR/USD.
USD still bullish
US 10-year yield rose to 2.43 the highest levels since March. A series of factor that provided a confusing outlook for the US look to have converged supporting demand for US assets. Economic data such as ISM and Durable goods have surprised significantly to the upside. While the divergence between real and survey data remains a question corporate American continue to produce hard revenue. In the current earning season 70% of S&P 500 companies that have reported beat profit expectations. In politics, tax reform seem to be mostly on track (rift on funding for tax reform based on repealing SALT deduction is the current issue) and in a Fox News interview, President Trump said he was considering reappointing Janet Yellen as Fed Chair. Finally, in the same interview discussing NAFTA, despite an initial threat to “terminate the deal”, there is a general feeling that comment was an negotiating tactic. Spillover into CAD and MXN was limited. Even minor correction in the Asia market failed to dent the USD strength against JPY and EM currencies. However, a more dovish fed and failure of tax reform to reach the floor will likely hurt the USD bullish trend. We remain cautious on digging to deep into USD long ahead of today critical ECB meeting.
