The most important event risk on next week’s calendar will be the highly anticipated European Central Bank monetary policy announcement. EUR/USD has traded in a narrow range ahead of the announcement as investors wonder whether it will be a hawkish or dovish taper. Having mentioned the need to make changes to their QE program for months, Mario Draghi is widely expected to announce plans to reduce the amount of bonds they purchase next year. The only question is by how much and for how long. Most analysts expect the ECB to cut bond purchases by EUR20B to EUR40B a month until June of 2018. They could make a smaller reduction and shorten the time, but that’s unlikely or they could cut more and lengthen the period of purchases to September or December. Either way, investors care more about the amount of bonds bought per month than how long they will be doing it, so the main reaction will be to the numerical target. Last month, the ECB suggested that not all decisions will be made at this month’s meeting because the euro was a source of uncertainty but the currency is now trading at 1.18 instead of 1.20 so they should not be as worried. Although there have been widespread improvements in the Eurozone economy since the last meeting (see table below) we believe that the central bank will opt for a dovish taper – cutting bond purchases by only 20B and extend it to September or beyond because they can always adjust it later and right now there’s too much political uncertainty. If we are right, the euro will fall and if we’re wrong and the ECB marries a more aggressive reduction with hawkish comments from Draghi, EUR/USD will hit 1.20 easily.
On a technical basis, EUR/USD is weak, having rejected the 50-day SMA at 1.1850 and appears poised to test the October 6th low of 1.1670. This may happen if US yields continue to rise and the market keeps banking on a dovish taper.
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