Trading the ECB: the most likely scenario, key levels and EUR/USD forecasts

As ECB will take center stage this week so Barclays Capital made some fundamental and technical forecasts concerning EUR/USD.

Fundamental Forecast.

• "An increasingly cautious Fed, coupled with an uncertain EM outlook, has benefited the EUR recently, contributing to tighter euro area financial conditions. Coupled with the recent drop in inflation expectations, such tightening has significantly raised expectations for additional ECB stimulus, making this week’s ECB meeting (Thursday) the market’s key focus."
• "The most likely scenario, in our view, is a continuation of the dovish rhetoric, followed by the announcement of a QE time extension in December, when the ECB updates its Q4 15 staff economic forecasts."
  
• "Moreover, recent price action in front-end euro rates suggests that the market is pricing a non-zero probability for a further deposit rate cut. While we do not rule out this possibility, we do not think it is an option for the next two meetings. However, we estimate that the rates market is already pricing a 20% likelihood of a 10bp deposit rate cut before year-end. In our view, a likely trigger for a rate cut would be a further material appreciation of the euro, possibly related to more signs that the Fed will remain on hold for longer. Although a measure of last resort, such policy action would be the most effective in weakening the EUR."
  
• "We expect more monetary easing before year-end. We believe that the details and magnitude matter for the price action of the EUR, as an extension and increase in the QE program would probably have less of an effect than an outright cut in the deposit rate. We think that it is just a matter of time until the ECB decides to drive EURUSD lower."
• "We believe that amid a lack of policy options, the ECB will step in in the months to come to try to fulfill its inflation mandate. As such, we expect further EUR downside. Our view should be supported by further USD strength, as monetary policy expectations in the US seem too benign compared with the healthy dynamics of internal demand in the US."

Technical Forecast.

• "We recommend buying a 3m 25delta EURUSD risk-reversal (EUR put/USD call) for a cost of 13.2bp (strikes: 1.1004, 1.1737, spot ref: 1.1357, atm vol: 9.19%), which offers a compelling risk-reward should EURUSD break below its recent range."
• "We maintain a short EUR/USD from 1.1278 targeting a move to 1.0460, with a stop at 1.1562."