ECB Meeting May Push Euro Higher

October 23, 2017

| Fullerton Markets

ECB may announce QE unwinding plan this week, buy EUR/USD?

Recent gains in dollar may end soon if ECB hints QE unwinding plan this week

The dollar index started to rebound since early last month. One of the main reasons was ECB President Mario Draghi showed no rush to tighten monetary policy. Many traders took profit on their EUR/USD long positions when the pair reached the key level of 1.20. However, risk of “ECB to tighten soon” cannot be ignored this week. If that happens, dollar could end its recent uptrend as early as this week.

The dollar index is worth watching as markets prepare for the ECB meeting and the Fed meeting the following week. The index appeared to get a boost in past few days after the US House voted for tax legislation and continued hawkish language from the Fed officials. Still, the index remained below 94 as of midday Friday, partly due to unclear ECB policy stance that limited the dollar-buying positions.

At the press conference last month, Draghi sent mixed signals about when the ECB might begin lowering its monthly purchases. European inflation in September remained below the ECB’s target, which could pressure the ECB to continue its stimulus. However, Draghi may respond to Europe’s general economic improvement by announcing a drop in the monthly asset purchase program this week, to be implemented next year. There were some talks in the FX market that ECB may announce a decrease in monetary expansion volume to 30 billion euro from the current 60 billion euro in this week's meeting, and the ECB will extend their stimulus program until the end of 2018. If that happens, EUR/USD could surge towards 1.19 and pressure dollar index to dip below 92.

We also need to keep an eye on the bond market this week, to see if any words from Draghi pushing the bond yield higher. Hawkish ECB could put pressure on US bond prices, sending yields higher. The benchmark US 10-year yield had begun moving up ahead of the ECB meeting, reaching 2.4% last Friday, the highest since July. However, the key factor driving EUR/USD exchange rates is the German-US sovereign bond yield spread. This will be one of the most reliable gauges to predict the direction of the upcoming EUR/USD moves. If the German-US bond yield spread narrows after the ECB meeting, EUR/USD is likely to move higher.

Our Picks

EUR/USD – Slightly bullish.

This pair may rise towards 1.1830 ahead of ECB meeting, as Draghi may hint stimulus unwinding plan.