• We expect the ECB to surprise the market on Thursday
• EUR/USD is likely to fall further on ECB QE and re-pricing by Fed
• We sell EUR/USD for a 1.0900 target; stop at 1.1940
Strategy
We expect the ECB to deliver a more aggressive QE scheme than the market expects on 22 January, specifically we look for a EUR 750bn broad-based buying programme. As a result, we look for the euro to stay under pressure in the near term as the ECB puts downward pressure on money-market fixings and, in turn, on the EUR. Moreover, the uncertain political situation in both Greece and Russia could continue to weigh on the single currency in the near term. Further out, we also look for the Fed to be priced more aggressively than the market currently does ahead of a first rate hike, which we have pencilled in for June this year; this should induce further USD strength.
Thus, we recommend selling EUR/USD spot (ref. 1.1578), targeting a move to 1.0900, slightly undershooting our 6M forecast of 1.10 (see FX Forecast Update: New tools, new regimes – ECB fuelling more EUR weakness but SNB to curb CHF strength, 19 January.)
We place a stop at 1.1940, hence tolerating a move higher should the market temporarily hesitate to buy into ECB determination to spur growth. We stress however that if the ECB disappoints, EUR/USD may bounce back near term (speculators are already very short EUR) but edge lower further out as a euro area recovery could then be much delayed.
Fundamentals
In a series of papers (see inter alia euro area outlook for 2015: Impact of broad-based QE, 16 January), we argued that the ECB will go (almost) all in on the QE programme that is likely to be announced later this week. Although the SNB floor exit last week may have advanced EUR downside in upping expectations of the ECB regarding QE, we think more EUR weakness is in store for the near term: the size and composition of the programme that we look for will almost certainly be positive for risk assets and broadly shift the EUR yield curve lower, providing a first leg for EUR/USD to head lower. Although QE arguably marks the start of a new ECB regime and suggests rates will be lower for an extended period of time, we stress that QE-driven EUR weakness should be, if not a one-off, then at least relatively short-lived and concentrated in Q1. The next leg of EUR/USD softness should then materialise in Q2 on a more hawkish pricing of the Fed ahead of summer.
Beyond 6M, the cross may stabilise around 1.10 and edge slightly higher again as a euro recovery gains traction on past monetary easing, oil prices bottom and there is scope for decent European equity market performance. Also, the potential for upside to rates should be limited in H2 by a Fed that will be wary of not tightening too fast. Thus, if one wants to play the unprecedented monetary-policy divergence between the ECB and the Fed that we envisage for 2015, we recommend doing this sooner (i.e. ahead of the January ECB meeting) rather than later, while there is still room for markets to be surprised by central bankers.
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