A reminder of ECB’s primary objective highlights why, with credit demand and growth so low, ECB has extended its QE. Core inflation, despite the rebounding of headline CPI, is stagnating under 1%, rather than pushing towards 2%. Though Draghi gave a more neutral economic outlook, he stressed that risks are mostly to the downside. The lack of any core inflation will keep ECB QE firmly in place, resulting in further downward pressure on the EUR.

The steeper EUR vol curve on ECB’s soft taper: As has become par for the course in recent years, the December ECB meeting surprised by delivering a soft taper that reduced the pace of asset purchases, but forestalled a vicious bond market rout by offering a maturity extension sweetener and keeping open the possibility of increasing program size/duration as required.

For the Euro, this hawkish surprise comes a few months ahead of our expected timeline, and should partially offset the dollar drama unfolding since last month’s US Presidential elections as well as any low-intensity European electoral stress next year to restrict EURUSD to a fairly tight 1.04 – 1.08 range over coming months.

FX vol implications of the ECB decision are murky: By muddying the Euro's hitherto clean anti-USD plus political stress narrative for Q1, there is a case to be made that ECB’s soft taper potentially crops the extreme left tail of the spot distribution for next year, restricts currency ranges and lowers realized volatility. FX gamma in that event should mirror the bearish reaction in Euro rates gamma that will continue to be hamstrung by a policy-enforced lid on front-end yields.

On the other hand, tension between competing in macro influences may not offer perfectly synchronized offsets on a day-to-day basis, especially when one of those drivers (US fiscal) is a high-risk policy item; in that case, a disciplined range on spot, while certainly not conducive to wildly higher realized vols, may not dampen them enough to make gamma ownership wholly unappealing for active delta-hedgers.

This keeps short-dated EUR IVs in something of a limbo: marginally softer in the baseline, but subject to intermittent noise/spikes that makes strategic view-taking difficult.

However, longer-dated implied vols, especially expiries spanning the Dutch and French elections should, however, prove to be a more reliable, persistent store of event risk-premium, Hence we reckon that this stimulates the vega longs.