EUR/USD Analysis ECB Preview

In terms of EUR/USD we have the ECB tomorrow and see limited upside and plenty of downside potential in the pair. Our view of the fundamentals sentiment and technicals below

ECB Expectations

“Financial markets are currently pricing in around 60bp of further easing for this year, i.e. 1-2 further 25bp rate cuts assuming a 25bp cut in September which we think is correct but given that the market is currently pricing in faster cuts for the Fed than the ECB and the strong correlations between USD and EUR rates, the risk is that ECB President Lagarde will be more dovish than expected and send the EUR lower.”

Inflation and Economic Outlook

Also, in an article earlier today, we expect the market to adjust its dovish view in terms of US rates. The idea the Fed will cut by over 100 bps and the ECB by just 60 bps doesn't add up with inflation coming down and an economy that looks like it could go into recession led by the powerhouse of the zone Germany.

In terms of eurozone the powerhouse of the zone is going down and will drag the whole zone with it – ECB needs to cut rates and their urgency is more than the Feds: “We don't know really why (or maybe we do very well but just cannot mention it...) we feel a decent amount of schadenfreude when it comes to the kaputt of the German economy. It has become one of our favorite macro sub-plots to track. Let's have a look again at the sad state of affairs in the once so mighty industrial power.” (THE ME)

Options Pricing

“The Euro is being held aloft against the Dollar and other currencies amidst significant demand from traders to hedge against options bets that are about to expire.” (PS LIVE)

If EUR/USD reaches the strike level, then traders are in the money however if traders don't think the strike will be reached, traders will probably try to minimize losses by buying or selling at spot rate levels i.e. the exchange rate you typically see quoted on your charts...

"These hedging flows tend to keep FX contained near the option strikes," (Richard Pace at Reuters). Looking at current positions, Pace says there are billions of euros of soon-to-expire EUR/USD option strikes nearby. Looking deeper, 2.4BN EUR strikes at 1.1050 expired on Monday, and 2BN expired at 1.1040-50 on Tuesday. Thursday sees almost 5BN between 1.1045 - 55, "that's huge," noted Pace.

It is big and the premium is getting destroyed as time decay sets in – If the euro falls away from the level tomorrow could these options be liquidated and help the USD? We will see but EUR/USD looks bearish to us and there are a lot of speculators also long in the cash market which points to limited upside and plenty of downside in our view.

Sentiment

We looked at the chart below in an article on Monday which shows speculators have piled in long to the euro as smart money commercial hedgers have sold which points to corrective downside action.

Volatility has been low in this pair but we think it could see an increase to the downside.

Technical Analysis

Our view of the technical action below and the important levels of support and resistance to look out for on the chart below.