The focus for traders at this Thursday's ECB meeting will revolve around the pace of PEPP (Pandemic Emergency Purchase Programme) purchases for Q3. Will they trim their asset purchases slightly or maintain the status quo by continuing at the current pace? Looking at rate markets, particularly the German 10-year yield and BTP-Bund spread (difference between Italian and German 10-year bonds) which have both moved lower recently, we can see dovish expectations are being priced by the market – i.e. holding the current purchase pace steady at €80 bn/month. I agree with this outlook of a status quo scenario. I am of this view for a couple of reasons:
- The dovish tilt in recent commentary from key ECB members, should enable the dovish voices to overpower the hawks this Thursday
- Financing conditions (yields and EUR FX) have tightened since their last meeting in April and tapering into all that bond supply necessary for the EU recovery fund would only lead to further pressure on broad financing conditions
- The economic recovery although improving is still not in a strong enough position to withdraw the punch bowl (vaccinations are still quite far below targets)
- The inflation outlook for the EU over the longer term is still anemic. Given the cautious nature of the ECB the far more likely scenario is to push tapering to the September meeting when economic activity will be on a stronger footing and the vaccine rollout should be close to target.
We’ll also receive updated economic projections. I expect the growth profile to remain unchanged/slight tweak to the upside. Inflation projections on the other hand could see a chunky upgrade on the back of supply chain disruptions, higher prices across the commodity complex as well as PMI surveys indicating businesses willing to pass through higher input prices onto consumers via final prices. Tapering on top of solid inflation revisions could produce a hawkish risk and prematurely tighten financing conditions putting the economic recovery in jeopardy. Lagarde will have to be on the ball during her press conference.
In FX land, the ECB maintaining the current PEPP pace and presenting a dovish message should cap any serious upside to the EUR/USD. Especially with a potentially hot US CPI number out just after the ECB meeting sparking further taper talk and causing a divergence in policy settings between the Fed and ECB.
EURUSD has been under pressure since the end of May. The candle low broke the range low/horizontal support as well as the uptrend line around 1.216. Price has now retraced to overcome the 21-day EMA and 1.216 level. The 1.224 price resistance seems to be the short to medium term cap on price as it proves too difficult for EURUSD to overcome. The divergence on the RSI as price made higher highs and the RSI made lower highs should still concern EURUSD bulls. The RSI dipped briefly below the key 52 support level and is now just above it. It will be interesting to see what price does as the RSI pushes up against that downtrend line. The target to the downside would be 1.21 and then 1.205 support further down. To upside 1.224 would be my point of interest.
Again similar to the Fed, the BoE compared to the ECB are certainly more “hawkish” and is doing little to push back against expectations of a faster timeline towards policy normalization. Again this should keep the direction of travel in EURGBP moving downwards. One risk to this view is the situation in Northern Ireland, with relations between the EU and UK becoming increasingly strained. This could spill over into other areas of the agreement, however, FX markets have remained mostly unreactive to minor flare ups so far.
Price has been in a consolidative triangle pattern, coiling and primed for a breakout in either direction. There is some support at 0.857, which if it was to give way then a downside breakout below the uptrend line becomes far more probable.
The RSI is also trapped between the 41 and 55 bounds, so watching these two levels will be important for clues to price direction. The 21-day EMA is below the 50-day SMA so short term momentum has a slight bearish tilt. There is some support at around 0.853 which would be a first initial target to the downside and below that the early April low of 0.847. On the upside after overcoming the 50-day SMA around 0.862 the next sticky price zone would be around the 0.864.