Analysis | April 20, 2021

KTM FX Weekly: What to expect from the ECB meeting this week?

  • The ECB messaging is the key driver for EUR this week.
  • German bunds continue to climb ahead of the ECB meeting.
  • The dollar continues to be ceded, a supporting factor to G10 FX.

This week’s big releases are the Bank of Canada and the European Central Bank. We don’t expect surprises at this week’s ECB press conference, which is our base case. Traders are eagerly waiting to calibrate Lagarde’s next policy steps. Most of the analysts expect a reduction of the Pandemic emergency purchase program (PEPP) is the next direction for the EUR. But when would it be? What comes next from the ECB?

PEPP recap:

The PEPP was launched a year ago to support euro area citizens in sustaining households during the COVID-19 pandemic crisis.

In March 2020, the ECB announced an emergency purchase program which the Governing council called the Pandemic emergency purchasing program (PEPP). It is a 750B euro program where ECB will spend on buying public and corporate securities. Since March 2020, the central bank purchased assets at a pace of 100B euros per month under this PEPP. In 2020 twice the PEPP was extended to a total of 1850B euros which accounted for more than 15% of the EA Gross domestic product (GDP).

Latest communication on PEPP:

In the latest March 2021 policy meeting, ECB president Lagarde pledges to main the PEPP at least March 2022. We expect the same communication theme on PEPP until the US will reach the tampering tipping point, as the US is leading the vaccine rollout program against the EU.

Reduction of the monthly bond-buying program is a delicate task. Last time in October 2017, when the European Central Bank announced that it would cut monthly purchases from 35billion euros to 30billion euros, the EURUSD spike from 1.1500 to 1.2560 an 8% rally triggered, before the actual tampering started. Hence, ECB communication is the key driver for the EURUSD from hereon. Anything after June 2021, we are expecting a pickup in the EUR momentum against the US dollar. Until such time, enjoy the range trading continues.

Here is the gist of what analysts forecasted at the upcoming April ECB meeting. Please see below. 

  • SOCIETE GENERALE said, “The ECB press conference on Thursday will no doubt be dominated by “What if” scenarios for the economy and PEPP bond purchases in 2H”.
  • ING reported that “The ECB should try to bridge the time to the June meeting without any new communication accident. In June, the eurozone should have seen some reopening; there will be new staff projections, and the ECB will reassess the pace of its asset purchases.”
  • UBS Weekly note said that “A shift in ECB messaging is premature to expect at this week’s press conference; in our view, President Lagarde is unlikely to do more than re-emphasize beefed-up PEPP purchases in the context of the program’s flexibility.”
  • Moody’s Analytics: “We aren’t expecting any surprises from the governing council. We expect the ECB’s Main Refinancing Operations rate will remain at 0% and that there will be no changes to its Pandemic Emergency Purchase Program”.

Bunds:

Looking at the Fixed income markets so far this year, Germany’s 10-year yields, the benchmark for the EZ, have outperformed US yields. Both the yields rallied since the beginning of this year, but US yields peaked at 1.75% and currently trading at 1.60%, whereas Bunds continue to shine with trading at a February 2021 high of -0.23. Visually the US is leading the recovery phase and well in advance of vaccine rollout.

Looking beyond a quarter from here, we expect EA would lead the way with the reopening of Europe’s economy and accelerating vaccine rollout in Europe. We are talking about things going to happen in Q3. It is premature to talk about those things in April, but that’s how the FX market prices in. We expect both the yields and bunds likely to outperform in Q3 2021, say 2% in US 10year yields and -0.17 in German 10-year bund.

The spread between German 10-year and US 10-year yields widened to -184 bps on Monday.

 FX: Logs first monthly uptick but technically overbought. 

EUR has been receding against the dollar from January high, mainly on the back of strong US yields. US 10-year yields rallied nearly 87% during 1Q 2021; at the same time, EUR lost 5% against the dollar. Coming to the current date, yields settled at 1.61%, ease from the March high of 1.76%. Besides, the EUR appreciated from 1.1700 to 1.2040 and capped at 100MA on Monday.

As per the latest ING’s FX positioning analysis, “EUR/USD positioning was unchanged at +10% of open interest, slightly above its five-year average, but well inside the one-standard-deviation band, suggesting limited room for additional long-squeezing in the pair.” This usually suggests a decline in the price by the supply-demand imbalance.

Supports located at 1.1940 and 1.1830. If the price is moving higher for resistances, watch out at 1.2050; it’s 100MA and 1.2100, it’s 61.8fib (Here’s the chart). If you are into the medium-term, then buy EUR on dips favor the trend with a target at 1.2300 and 1.2450 in Q3-Q4 2021. Focus on repricing the European recovery momentum would support this view.

It is important to always keep in mind the risks involved in trading with leveraged instruments.

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