The single currency started the week on the back foot as the ECB decision looms. The euro was down roughly 0.30% against the US dollar but lost even more ground against high quality commodity currencies such as the Aussie and the Kiwi, which gained 0.30% and 0.45% respectively. For the past two weeks the single currency has been trading in a volatile range as investors await the European Central Bank’s penultimate meeting of the year. Although there is absolutely no doubt that the ECB will trim its monthly bond purchase, which currently stands at €60bn/month, the date of the announcement is still quite uncertain.
There is a high probability that Mario Draghi will make this announcement on Thursday as waiting longer would send a negative signal to investors. Indeed, waiting until December will suggest that the ECB is not happy with the current economic conditions in the EU. However, In order to avoid throwing the cat among the pigeons, Mario Draghi will likely adopt a very cautious tone and will also reiterate that the ECB could again potentially increase its support to the economy should the situation require. Indeed, the one thing that Draghi wants to avoid is to trigger further EUR appreciation as it would both damage the economic outlook but, most importantly, it will add pressure on an already anaemic inflation.
Looking at the market this morning, EUR/USD realised volatility has reached its lowest level since August 2014 which suggest that investors are too worried. However, the 1-week implied volatility has spiked to 9.36%, compared to 6% a week ago. The 1-week 25 delta risk-reversal measure rose to 0.53% indicating that investors are buying protection against an upside move in EUR/USD. On the longer-term, it is worth mentioning that the 6-month 25 delta risk reversal measure has returned in negative territory, sliding to -0.17%. This move below the neutral threshold is clear indication that investors await a reversal of EUR/USD within the next 6-months.
In addition, the appreciation of the Swiss franc against the single currency also suggests a certain tensions among investors. Although we believe that the market is almost done pricing in the upcoming QE reduction, the single currency still has upside potential, though it is limited thanks to political uncertainties.