Last December the European Central Bank (ECB) offered unlimited 3-year funding through its long term repo operation (LTRO), at a cost of 1% to more than 500 banks, which raised almost €500bn ($665bn). Next week (February 29) the ECB is planning another LTRO and recently enlarged the eligible collateral that banks can place at the ECB, in a clear incentive for banks to use the cheap funds. Some estimates of borrowing in the next LTRO have been as high as €1trillion ($1.3t), but taking into account some recent comments from management of European banks, probably the borrowed amount should be lower. In a recent survey from UBS, the average forecast was around €650bn ($850bn).
With the second bailout package for Greece recently approved, I think that, at least in the short-term, the outcome of the next LTRO will be the main event for the direction of the EURUSD. In last December, the EUR appreciated towards the operation date but fell afterwards.
To forecast the possible response of the exchange rate, we must take into account the possible LTRO demand:
Under €250bn: a demand near zero is very improbable, given that banks are unlikely to reject cheap funding. If banks raise an amount close to half the last LTRO, could calm fears over financial sector needs and be slightly positive for EUR. In this case, the EUR/USD could test 1.35 to 1.40;
Around €500bn: similar demand from the December operation. This is close to market expectations and should have a limited impact on the currency, trading in the 1.30-1.35 range;
Between €750bn and €1Trillion: possibly imply that the financial sector remains vulnerable and if the amounts raised go back to deposits at the ECB, will be seen as negative for the Eurozone debt crisis, because banks won't take sovereign risk, and negative for the Euro. The EUR/USD should go lower to 1.30-1.25.
In the last LTRO the EUR fell in the following weeks, but at that time the European sovereign risk was a bigger threat, in the short-term, than it is now. I think the most probable outcome is a lower demand than in the first LTRO and this should be positive for the EUR/USD. This can be played through an ETF, such as Rydex CurrencyShares Euro Trust ETF (FXE).