Euro Bulls Know Which Level to Defend on a Dovish ECB Outcome

(Bloomberg) -- The foreign-exchange market has come to price in a high chance that Mario Draghi will next week repeat concerns voiced in September over the euro’s appreciation. Should that prove correct, the capitulation point for long positions in the shared currency seems well defined.

The euro consolidated this week after verbal intervention by policy makers over its recent strength. Following, or even prior to, the European Central Bank meeting on Jan. 25, a daily close in the euro-dollar pair below the January breakout point near $1.2090 would put the common currency’s latest appreciating trend to the test.

Another immediate risk for the euro comes from German politics, with the Social Democrats holding a special convention on Jan. 21 to decide whether to pursue formal talks with Angela Merkel’s Christian Democratic Union-led bloc.

The bullish trend channel initiated on Nov. 7 has seen the euro appreciating by more than 6 percent versus the dollar. Its lower band is currently around $1.1900, which also close to the 55-daily moving average. Should that last support fail to hold, some analysts may have to rethink their optimistic first-quarter outlook for the common currency.

Indeed, it is possible that the ECB President will talk the euro down. The minutes of the central bank’s December meeting that were hawkishly interpreted by the market came at a time when the euro traded 4 percent lower than current levels. Although Draghi won’t comment on specific exchange-rate levels, he could signal the Governing Council’s discontent with the speed of the recent spell of appreciation.

Whether Draghi’s remarks will have the effect he aims for is another story. Given that positioning is lighter following this week’s price action and the market doesn’t seem overtly long on the common currency, any euro weakness fueled by ECB comments alone could be short-lived as was seen in September. Back then, the euro fell to $1.1932 from $1.2020 during the first minutes of Draghi’s press conference, only to close the day with a gain of 0.9 percent at $1.2023.

Option traders for once think that any reference to the euro, or the absence of it, will create significant price swings in the spot market, as shown by the recent upward march in one-week implied volatility. The currency’s volatility skew, clearly favoring euro upside, suggests it may take a very dovish Draghi to keep investors from fading a dip.

What to Watch

• On Jan. 22, the U.K.’s European Union Withdrawal Bill switches to the House of Lords
• The next day, the World Economic Forum opens in Davos, Switzerland; the Bank of Japan also meets amid expectations that it may begin to discuss policy normalization
• Euro-area PMIs, U.K. GDP and employment report, U.S. PMIs and GDP; to see data calendar, click here
  • Chicago Fed President Charles Evans scheduled to speak on Jan. 24

To contact the reporter on this story: Vassilis Karamanis in Athens at vkaramanis1@bloomberg.net.

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Anil Varma, Scott Hamilton

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