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The economic recovery in the eurozone has strengthened and thanks to the prospect of an imminent exit from the ECB’s expansionary monetary policy, EUR has appreciated.
After the ECB already removed the reference to further rate cuts from its statement. However, some central bankers seem to be getting cold feet, or so the reports suggest.
As a result, EUR-USD ran out of steam in the area of 1.1450 and for the time being the pair reversed from there.
While FX vols enter H2 meaningfully cheap versus macro drivers and should mean-revert moderately higher. A U-rather than a V-shaped rebound is consistent with past vol cycles and mixed carry trade positioning.
In regards to the former, President Draghi said that while current policy is correct, "reflationary forces" suggest potential room to pare stimulus, very gradually. The market has interpreted this as tapering the QE programme next year, driving German yields higher and EURUSD up through recent 1.1300 highs.
While the bond move is key to supporting the EUR, the broader USD has played its part coming back under pressure.
The market interpreted the information ECB President Mario Draghi provided at the opening of the ECB forum in Portugal as completely new information and used that as a reason to raise rate expectations which had been lowered following the last ECB meeting. Everything all told Draghi pointed out that the ECB was prepared to consider a slow exit from its expansionary monetary policy, which is nothing completely new. However, he used two new arguments in his speech:
1) First of all monetary policy would become even more expansionary even if everything was left unchanged if the economic situation improves, and
2) At present, it was temporary factors putting pressure on inflation developments which a central bank could look through. At the same time, Draghi underlined also that the ECB had to be very prudent and that the exit from the expansionary monetary policy would have to be very slow. A reference to the forward guidance was also included. Draghi’s speech provided wings to the euro, by now EURUSD is trading above 1.1350.
EUR-cross vols should be more muted in H2 as data momentum and investor focus on Europe cools. Buy 2M 25D EUR call switches in EURUSD vs EURPLN and sell EURNOK – EURSEK correlations via a vanilla option triangle.
