EUR/USD saw modest consolidation after the recent strong moves, as traders questioned exactly how aggressively the ECB would act later this week in its central bank meeting.
The pair experienced modest buying interest at 1.2225 just ahead of the conversion line on the Ichimoku cloud. Expectations have been ratcheted up in recent times, given comments from Ewald Nowotny and Mario Draghi, with the market now expecting a range of measures to be announced such as a resumption of the bond buying program (Securities Market Program or SMP), bond-buying using the EFSF, negative deposit rates, and interest rate cuts.
An article in German publication Der Spiegel yesterday highlighted the growing divide amongst the ECB at present and it is quite clear that Mr Draghi may have pushed the market into believing strong action will take place before it is actually a done deal within his internal ranks. We feel there is genuine reason to believe we will be disappointed this week and the high expectations of the market might not be met. It is worth remembering that a lot of the measures being speculated on are designed to bring down yields and make funding sovereign deficits by auctioning bonds cheaper.
Bringing down yields artificially by actions from the Central Bank subtracts the need for structural reform, hence the moral hazard argument that has kept the German Bundesbank from following Mr Draghi’s lead. On the other hand, we feel the ECB President knows the high expectations that have been built into asset prices and a failure to act will see much of the recent good-will being unravelled. Saying that positioning still favours a stronger euro in the short term, we feel the best way to play this may be through a momentum strategy.
On Friday EUR/USD traded to 1.2390, but couldn’t close above the July 19 high of 1.2324 (the pair closed at 1.2322), so holding off until we see a daily close above this level would suggest a stronger move above 1.24.