(26 OCTOBER 2017)DAILY MARKET BRIEF 1:ECB meeting: a subtle balance between hawkish and dovish

Today, the main event is obviously the ECB meeting with announcement of the interest rate decision at GMT 11:45 followed by a press conference at GMT 12:30. The question is not whether the European Central Bank will keep interest rates unchanged, nor whether Mario Draghi will announce a reduction of the asset purchase program, but rather the size and timing of the latter. The market is expecting the ECB to trim its monthly purchase by €20bn down to €40bn, while the program should be extended by at least six months (June 2018) if not nine months (September 2018).

Mario Draghi will have the difficult task to announce a hawkish move without triggering a sell-off in the bond market together with a rally of the single currency. Therefore Mario Draghi will give investors what they want: a reduction of the QE; however he will also reiterate his call for cautiousness and remind market participants that the ECB could potentially increase again its support to the economy should the situation require. Such a balanced move would allow the ECB to prevent adverse movements in financial market while moving forward with the QE reduction.

After extending gains yesterday, EUR/USD is trading sideways on Thursday morning at around 1.1825. EUR/CHF printed a new multi-year high yesterday at 1.1705. We think the ECB is not quite happy of the recent sharp appreciation of the euro. Therefore, we anticipate that Draghi will emphasized the subdued inflation pressures together with the risk of a excessively strong EUR to the outlook.

In the short-term, the increase in the price EUR/USD call options compared to put options suggests that the market is positioned for further EUR/USD strength. However, in the longer term, this is a different story as puts are more expensive than calls (6m 25 delta risk reversal is equal to -0.175%), suggesting that investors are rather bearish on the medium-term outlook for EUR/USD.

By Arnaud Masset