ECB Preview: Sell The News, Buy The Dip, But Where Exactly?

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Includes: DRR, ERO, EUFX, EUO, FXE, ULE, URR
by: Andrew McElroy

Summary

The market is long into the ECB meeting on Thursday.

It expects the ECB to pave the way for a September announcement on QE tapering.

What will happen to EURUSD in various scenarios.

Thursday 8th June is an important date for currency traders. The General Election in the UK will have implications for the pound (NYSE:FXB) as I wrote about here. The euro (NYSEARCA:FXE) will also be volatile as we await the ECB interest and deposit rate decisions, plus the monetary policy statement and press conference.

In this article I will look at expectations for the ECB meeting and how the euro may react in various scenarios.

The ECB Expected to Deliver

You only have to look at a chart of EURUSD to know the market is long into tomorrow's meeting.

The French election results ignited the move which has catapulted prices nearly 6% higher in a month.

With political uncertainty out of the way, it was widely thought June's ECB's meeting will pave the way for tightening measures later in the year.

But don't expect the ECB President Mario Draghi to boldly declare QE tapering tomorrow. The ECB has remained very tight lipped about policy and most analysts are only looking for small changes in language. Here is what HSBC expects:

'Our central case is that there will be no significant changes to forward guidance. Instead, the ECB may simply tell us that it discussed exit strategy and, when the time comes, exit will be gradual and data-dependent. We also assume that the ECB will continue to argue that the -40bps deposit rate is not adversely affecting the efficacy of monetary policy. If our central case is wrong and there is a change in wording, we think dropping the clause that key policy will remain at present or lower levels "well past" the horizon of net asset purchases would make most sense. This could increase policy flexibility once QE is fully tapered.'

So it seems the most bullish case only entails the dropping of two words in the forward guidance. There may be more clues from the tone in the press conference, but there is unlikely to be anything specific.

The main takeaway will be how the ECB prepares the market for the next important meeting in the fall. Data has picked up significantly in the eurozone and pressure is mounting for the ECB to tighten next year.

The consensus view is that the ECB will announce specific plans in the September meeting for QE reduction in 2018. Excuses are running out for the central bank's dovish stance.

So the question is, will the ECB prepare the market for an announcement or not?

Scenarios in EURUSD

Bearish

I sometimes wonder if the market has got ahead of itself a bit as the ECB has kept very quiet and done little to inspire such a rally in the euro. Solid data and speculation have driven the advance.

If the ECB were to remain dovish and make no concessions to policy change it would most likely cause a sell off. But to where?

In the eventuality that the ECB lets the market down, it is likely EURUSD would return to where prices broke out in April and re-test the 200dma in the 1.08 area.

If this were to happen, EURUSD could be a decent buy. After all, the ECB will tighten at some stage, and speculation will once more build and fuel a rally like the one we just witnessed.

Bullish

If the ECB gives the bulls what they want and paves the way for a September announcement, we can expect a spike higher. The likely destination for this is 1.14, where the long term channel lies.

It is likely we will see profit taking in this area, but a full reversal may not materialize. If the ECB does in fact tell us the September meeting is 'live', euro longs will on one hand be confronted by a long wait over summer during which price could drift back down, but they won't want to be left out of the next rally front-running the announcement.

In other words, profit taking on partial positions could cause a dip from 1.14, but any dip towards 1.11 could be a decent buy.

Likely price paths can be mapped out using Elliott Wave.

At the moment we are approaching the completion of a 3 wave move from the 2017 lows. If EURUSD has indeed bottomed, we would need to see an impulsive 5 wave move.

This means EURUSD would need to consolidate through the summer in a wave 4 (perhaps in proportion to the last consolidation) and make another high into the September meeting.

This scenario is long term bullish as once a 5 wave move completes and corrects, another proportional move higher would begin.

There are of course many different permutations and possibilities, but I only prepare for situations where I think I have an edge. I don't really care if the bullish or bearish scenario transpires as I rarely take positions before an event and will trade either setup after the news is digested.

Conclusions

The ECB policy statement and press conference will cause volatility in the Euro tomorrow. Rather than guessing what the ECB will do or say, we can prepare ourselves for different outcomes.

You may hear people say, 'sell the news' or 'buy the dip', but this is very vague.

My analysis suggests 1.14 is where we can sell the news, and 1.11 is where we can buy the dip if the ECB changes its forward guidance.

If the ECB stays dovish, I'd be careful of an overly long (and disappointed) market and wait till 1.08.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in FXE over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.