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July 18, 2017

It is too early to expect tapering ECB balance sheet

It is too early to expect tapering ECB balance sheet

In the foreign exchange market trends often begin before the main reason for the rally appears, not as a sequence of it. That is why at the end of 2013, a large-scale dollar rally began, as the Fed announced its readiness to reduce stimulus. By the way, it happened at the summer conference in Jackson Hole, which this year will see the head of ECB Mario Draghi as a guest.
Examples include the Japanese yen collapse as soon as Abe announced his policy of “three arrows”, although six month were remaining before the launch of QE (quantitative easing) from the Bank of Japan.

Similarly, it’s the case for euro: it is enough the intention of the European Central Bank to change the policy, and the major players will proceed to step-by-step long positions that can cause a significant rise of the euro in subsequent years.

Since the ECB adheres to inflation targeting quite rigidly, and the trade and budget balance has long been in favor of the euro, discipline in monetary policy can turn into a new long-term trend of strengthening the euro.

The pair EURUSD crossed through the resistance level of 1.15, first time since the end of 2014, the battlefield seemed to be void as it stabilized near 1.1530 level ahead of the ECB event on Thursday. The the pair may face a rebound during a test of 1.16 while the scale of retracement will depend on whether ECB head will appreciate economic changes considering them sufficient to spur inflation or dismiss them stressing on the necessity of QE to bring inflation on sustainable track. The pullback on EURUSD seems imminent to me, the only problem is to find the right point of entry. Picking round number appears to be a good idea but waiting for Draghi is necessary to go with guaranteed catalyst for the moves.

Pre-event trading appears to be most manageable episode for me as investors are trying to second-guess exposing themselves much and causing erratic moves on the pair. Clearly they expect Draghi to be bullish but part of investors will close their positions before the ECB meeting what will cause a correction.

Here is the scenario I expect to happen:

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