With inflation and inflation expectations in Europe at truly worrying levels, Mr Draghi and company will want to prove that monetary policy has not reached its limits. Importantly, the ECB will want to positively impact financial markets and in theory this should encourage traders to continue selling EURs.
With iron ore, oil and base metals rallying strongly of late and the Reserve Bank of Australia unlikely to ease policy anytime soon, being long AUD still holds attractions. Subdued volatility in financial markets is also supporting the AUD as traders search out the higher yielding currencies.
The trend is firmly lower, and aligning one’s directional bias to the prevailing trend will increase the probability of a profitable trade. Technically, the close below the neckline of the double top (see chart 1) targets A$1.4550, so the fundamentals, market conditions and technical set-up all suggest lower levels.
The key measures to expect from the ECB
- A cut in the deposit rate by 10bp to -0.40%.
- An increase of monthly bond purchase (quantitative easing or QE) pace by EUR 10bn to EUR 70bn. A EUR 20bn increase in monthly bond buying would surprise and help this trade idea.
- An announcement, or at least a strong hint of a two-tier system on interest rates charged to banks who hold reserves on deposit with the ECB. The idea is to reduce the impact negative deposit rates have on banks' profitability. Extend the bond buying program (QE) by a further three months to at least the end of June 2017.
- Guidance from Mario Draghi that they can do more as and when needed. This is the key part to avoid a repetition of EUR rally seen at the 3 December meeting – see lower chart.
- The potential for a major surprise, such as announcing they intend to buy private sector debt or even equities similar to Japan. The probability of these actions is less than 50% though.
Risks to the idea
The key risk is that we see a repeat of the December meeting where the market priced in aggressive easing and were bitterly disappointed, causing a strong spike in the EUR. A strong and unexpected increase in market volatility and a new bout of negative market sentiment would see EUR/AUD rally as the EUR benefits in times of risk aversion due to Europe's high current account surplus.