Finding opportunity in the ECB meeting

Italian Prime Minister Renzi made a very poignant remark overnight that his dream is for ‘parity’ between the EUR and USD by 2016. He may well be in luck.

Source: Bloomberg

Using the European Central Bank’s calculations, every 10% decline in the EUR should result in 0.5% of upside pressure for inflation, which of course is their primary concern – their mandate is to get inflation close to but below 2%.

To make Europe competitive, the ECB can really only use its currency as a policy tool, with little faith that governments will ever really enact key fiscal reform. Still, the highly anticipated ECB meeting is upon us and traders are now prepared to get the finer details around the ECB’s much-anticipated bond buying program. It’s this policy which many feel will contribute to continued EUR weakness.

The size of any bond-buying program has long been speculated on and the consensus has ranged from €550 billion to €600 billion, depending on the news source. It seems this is the wrong way to look at things and the key is actually whether the ECB can expand its balance sheet enough to push it to similar levels seen in early 2012. For this to occur we would need to see over €700 billion in additional asset purchases.

Market speculation is that the ECB will now release a program of €50 billion a month, which will include investment-grade sovereign debt, among other assets. The duration of the purchases is not yet known and will be a clear focus for traders in tonight’s (23:45 AEDT) ECB statement, as well as Mario Draghi’s subsequent press conference some 45 minutes later.

I suspect we will hear they intend to buy bonds until the end of 2016, which would result in a program of €1 trillion. A more bullish move would be to signal a more open-ended stance, which could actually see the balance sheet move beyond the levels seen in 2012 as they buy bonds at a rate of $50 billion per month until they achieved their mandate.

Of course, there are many more details the market will be interested in, such as what bonds they will actually buy and what maturities they will target (recall many of the shorter-dated bonds have negative yields). Will speculation be correct, assuming the ECB will make clear purchases are to be in proportion to key capital contributions, while the actual buying will be undertaken by national central banks to spread the risk evenly?

We may actually not hear all of this detail tonight and the ECB may wait until the March meeting to provide the finer details.

Looking at how markets are positioned, EUR/USD has found good supply (on the hourly chart) into the $1.1650 area. This looks like the key sell zone. However, good bids are seen into $1.1550, so a break here would push the pair to test the 16 January lows. On the daily chart, the pair is oversold but this merely reflects the strong trend, which naturally should be respected.

European equities look strong and I like price action on the French CAC (‘France 40’ on IG’s platform). Having broken above the June downtrend earlier in the week, the index is honing in on the 4,500 area, which coincides with the strong reversal seen in August and September 2014. A break here would see the June pivot come into play. The DAX (Germany 30) has printed a higher high and looks strong, with pullbacks being pounced on.

Gold has seen indecision on the daily chart, but is also coming off overbought levels and the inverted head and shoulder pattern continues to target $1345.

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