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The European bond market has been bid all year and is definitely one of the key talking points. The fact the Italian and Spanish ten-year yield has fallen from 4% to under 2% over the year tells me that a full-blown government bond buying program, or quantitative easing (QE) is partially priced in. The German ten-year bond is now at 76 basis points, meaning if you lent money to the German government you’d be expecting an annualised return of 0.76% and that tells a fairly clear picture.
Expectations on near-term ECB action are high and rightly so, as we’ve heard from a number of key officials recently that QE is on the table. Still, it’s very unlikely that this program will be announced today.
We could see the ECB announce that it intends to buy corporate bonds. This would increase the scope of assets the central bank can buy and, in turn, help them achieve a bigger balance sheet. As we have seen over the years and using the Bank of Japan and the US Federal Reserve as an example, the size of the balance sheet can have strong ramifications on the underlying currency (i.e. the bigger the balance sheet, the weaker the currency).
The ECB will be absolutely cognisant of market expectations tonight and will do what is necessary to keep the EUR from rallying too much. My long held target on EUR/USD has been the 200-month average at $1.2228, which also coincides with trend support drawn from the 2005 low. Over the years, this moving average has been huge support and therefore a break here could be hugely significant. The stochastic oscillator is also at extreme low (again on the monthly chart) and, as you can see, moves off the 200-month average, with a bounce in the stochastic indicator could be very important. My guess is this time is different but price will tell.