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Article / 04 December 2013 at 16:11 GMT

ECB's Draghi needs to plunge a fork into the EURUSD rally

Head of FX Strategy / Saxo Bank
Denmark

By John J. Hardy

The EURUSD has picked itself up off the mat since hitting a low after the rate cut by the European Central Bank (ECB) on November 7. The rate tinkering simply hasn’t been enough to push the EUR lower. Strong, key US data from this week and today has helped to soften the EURUSD rally today, although the ISM non-manufacturing data point was a bit disappointing. Tomorrow’s ECB meeting and Friday's US employment report will be the key to perhaps finally putting a fork in the near month-old, sluggish, yet persistent EURUSD rally.

For a full-scale EURUSD sell-off to unfold from here, we need to see ECB president Mario Draghi hint at something bigger than tinkering with the interest rate tomorrow. I really don’t think that the path lower for EURUSD is paved with another rate cut or the much discussed negative deposit rate, which might be worth a couple of figures of selling at most (as we saw with the November ECB meeting exercise).


draghi

Will ECB President Mario Draghi step up to the plate tomorrow? Photo: Shutterstock.com


Rather, I think the path lower is paved with the expectation and eventual reality of the ECB unleashing fully fledged quantitative easing. Tomorrow, we need to see a clear hint of some kind of QE plan in the works to get more than a temporary knee jerk lower. The first phase of a new path might be a new LTRO (the big 3-year LTRO runs out next year and will need a replacement of some kind) initially, but ultimately, bond-buying would have a far larger impact. Stay tuned!

If we get a very passive ECB tomorrow, with no rate cuts and only vague reference to other policy tool options, we could see EURUSD shoot to 1.3700 and even test the highs for the year above 1.3800 (I rate this as possible, but with a low probability). Meanwhile, a third wave lower scenario could be kicked into high gear with a super-Mario message on the policy front along the lines of his July 2012 speech and another plus 200,000 payrolls report and unemployment rate drop from the US on Friday. Let’s take it one step at a time, regardless.

Chart: EURUSD
EURUSD may have finally completed a sluggish, three-wave rally of consolidation and could be looking to launch a brutal wave three in a five-way sequence if the message from Draghi and company is particularly compelling. It’s tough to make this call as the core/German contingent at the ECB will only be dragged kicking and screaming into a strong easing stance, but the technical set-up is in place if we get a strong downside continuation wave. There is something almost “magical” at this point that the classic 161.8 percent projection precisely targets the massive, massive support zone at 1.2750. Stay tuned — the next couple of days are pivotal.

 eurusd

Source: Saxo Bank

— Edited by Martin O'Rourke

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