Euro Traders Ready For ECB Decision, EUR/USD Range At Risk

The Dow Jones FXCM Dollar Index advanced for the first time in three days, but the absence of a supporting fundamental drive meant its performance was lacking for strength. The economic docket was barren for the day; and the top, direct headline was that Moody’s said it expected further positive US credit events over the coming months as the fiscal crisis was worked on (and the dollar’s relief rally in the US avoiding a downgrade after the Fiscal Cliff has been spent).

To see the greenback once again climb with zeal, a market-wide wave of risk aversion is necessary to activate the currency’s safe haven status – though we are starting to slowly see US yields overtake global counterparts, it doesn’t present the same level of advantage as its reserve appeal. That being said, the VIX Volatility Index tagged a fresh five-and-a-half year low Wednesday and the S&P 500 seems anchored just off multi-year highs. We should watch for the influence of the upcoming ECB rate decision and Friday’s Wells Fargo earnings report on the dollar, but a serious trend needs definitive "fear."

Euro Traders Ready for ECB Decision, EUR/USD Range at Risk
The euro was a mixed bag Wednesday, caught up in the meandering pace of general risk trends. This same lack of volatility has helped EUR/USD in particular maintain an otherwise risky 135-point range above the closely watched 1.3000 figure. Given the pair’s lack of breathing room, a necessary breakout is a high probability. All that is needed is a little encouragement from a significant fundamental development.

Of course, the most influential catalyst to start this benchmark pair moving - and keep it running in a meaningful trend - would be a serious shift in market-wide, investor sentiment. While that high threshold is unlikely to be met in the immediate future, top event risk in the ECB rate decision scheduled for the upcoming session may prove influential enough to force a breakout on the euro’s reaction.

The danger in the forthcoming European Central Bank policy decision is market complacency. Though well founded, both the market and economists are heavily pricing in no change to the benchmark rate. In fact, according to the Bloomberg consensus, 50 of the 55 polled economists expect no change and overnight swaps show no probability of a rate cut. Therein lies the potential for market volatility.

Looking back to the December monetary policy meeting, there was mild speculation circulating that the central bank would hint at intentions to cut moving forward. President Draghi repeated that rates were "accommodative" (suggesting no change in mood), but there was also a hint that at least some members voted for a cut. The central banker also said that there was a "brief" conversation of the consequences of a negative deposit rate – this rate is already at zero. Where the most carry over risk comes in from the last meeting though was the ECB’s downgraded view for 2013 GDP (from a 0.5 percent growth to a 0.3 percent contraction) and inflation (below target at 1.75 percent).

With a view of further recession in the eurozone, inflation below objective and the risk of a renewed financial crisis; there is plenty of support should policy officials decide to cut rates further. For the euro, though its benchmark rate is low, cutting the yield even further would significantly undermine its appeal especially against a currency like the dollar whose benchmark is already at absolute lows. Then again, the alternative would be no change with no change to the gloomy forecast (it wouldn’t change this quickly) which would leave the euro unfazed as that is already priced in. That is a good fundamental risk-reward as we keep a close eye on the 1.3000 level for EUR/USD.

Japanese Yen Gives Back Bulk of the Gains from its Biggest Rally in Months
Following its strongest advance in over four months, the yen proceeded to give back all of its gains Wednesday. The yen crosses are certainly exposed to a correction whether instigated by natural profit taking, risk aversion or a combination of the two; but in extremely quiet market conditions like those we are currently experiencing, the status quo means more carry. The fundamental conversation outside of risk trends for the yen continues to focus on the possibilities of the BoJ adding stimulus and raising the inflation target. Yet that is still two weeks away.

Australian Dollar Firms as Low Volatility, Chinese Trade Data Pumps Return
We can tell what fundamentals truly matter for an economy when we see how the currency reacts as the news crosses the wires. Over the past few days, the biggest trade deficit in years and a jump in home sales barely nudged the Aussie dollar. However, this morning, a significantly stronger-than-expected Chinese trade figure for December leveraged a 55-pip AUD/USD rally. Strong trade for Australia’s largest trade partner translates into Growth for China and demand for raw materials from Australia. Don’t expect this data to sustain a rally without risk though.

British Pound: Will the Bank of England Provide Volatility?
Though most eyes will be on the ECB rate decision in the upcoming session, the Bank of England (BoE) will also be on tap for its policy gathering. The difference between the two, however, is that the latter is mum when it holds policy unchanged; and even if it did move, a shift in asset purchases would likely result in the same lack of surprise from the pound. Expect more from a secondary wave from the ECB outcome.

New Zealand Dollar Advances Across the Board, Trade Data Ignored
Despite being an indirect fundamental driver, the Chinese trade report had more influence over the Australian dollar than the New Zealand’s own account had over the kiwi. It certainly didn’t help those looking for volatility that the November trade report printed almost exactly in line with a NZD 700 million deficit. The QV House Prices report for December was similarly disarming with a 5.7 percent match to the previous month.