Following the dramatic move in foreign exchange markets the previous Thursday, when the euro surged on the back of a smaller-than-expected boost to ECB stimulus, it is worth asking what’s next for euro / dollar. Of course the short-term pain felt by euro bears was intense, but there could be some interesting medium-term implications outside the short-term pain.
First of all, although euro bears were dealt a serious blow last Thursday, they are apparently slowly coming out again. Euro / dollar is currently trading well off its Thursday high of 1.0981 at around 1.0863 and the majority of traders still see the euro heading lower in the next three to six months. Monetary policy divergence between the Federal Reserve and the ECB – although priced in to an extent – is still there and the ECB might be tempted to do more if inflation keeps disappointing. On the other hand, barring a huge surprise, the Fed should raise interest rates on December 16 and follow up with at least another couple of interest rate hikes during 2016. For the euro to seriously challenge its downtrend and head higher, this picture must change. Either the Fed must stop raising rates or even think about cutting (eventually) and / or the ECB should think about stopping its QE program and eventually raising interest rates. The possibility of this reversal in the next year appears to be small.
This does not mean though that the dollar will now rally just as hard versus the euro. The future drop in euro / dollar may not be as steep given that the ECB Governing Council does not seem to fully agree with Draghi’s dovishness. Economic data will also begin to be more important, as the market disregarded some euro-positive numbers before the ECB meeting; counting instead on Draghi to come through on the day of the meeting. The market should also become more suspicious towards Draghi. His famous London speech in 2012 where his promise of “whatever it takes” pretty much alleviated fears concerning the Eurozone crisis for the single currency’s largest countries, may not be easy to repeat following the December 3 meeting.
A lesson from recent history could prove useful. In December 2014 after the Bank of Japan announced its QE expansion, there was a very sharp move in dollar / yen which drove it all the way up to almost 122 yen from the 108 level. Yen bearishness was at a peak back then, but a full year later, dollar / yen is still not so far from that level at around 122.86. Therefore it could also be interesting whether the run up to the ECB meeting was also the peak in euro bearishness. Provided of course, that, like the Bank of Japan, the ECB does not expand its QE program further.
To sum up, calls for fresh lows in euro / dollar and eventually parity (or even below parity) might resurface in the next few weeks but probably the time frames will be less immediate and more medium-term. For the euro itself, range trading will probably be the order of the day until important enough developments take place either in the Eurozone or the United States. A convincing break above 1.15 (and not just a spike) will be necessary for euro bears to seriously reassess their position. It is also worth remembering that the euro could gain if risk sentiment turns negative.
Risk Warning: Forex, Commodities, Options and CFDs (OTC Trading) are leveraged products that carry a substantial risk of loss up to your invested capital and may not be suitable for everyone. Please ensure that you fully understand the risks involved and do not invest money you cannot afford to lose. Please refer to our full Risk Disclosure.