ECB Anticipated to Implement Third Rate Cut of the Year
Expectations for the ECB Meeting
The European Central Bank (ECB) is anticipated to cut interest rates for the third time this year on Thursday. This follows a second-straight meeting, accelerating the pace of easing as inflation quickly recedes alongside a worsening economy. Bloomberg analysts unanimously forecast a quarter-point decrease in the deposit rate, bringing it to 3.25%. The euro is poised for a fourth consecutive day of losses against the US dollar, as policymakers are expected to indicate a readiness to further relax policy.
Market Predictions and Positioning
Bloomberg FX strategist Vassilis Karamanis suggests that options traders are not anticipating significant changes for the euro resulting from the ECB meeting. However, positioning could be crucial. The common currency's overnight volatility reached one of its lowest levels ahead of an ECB decision since officials began raising interest rates in July 2022. On the eve of the meeting, hedging costs were at their lowest in three years.
The relatively low volatility reflects market consensus for a quarter-point cut and limited expectations for concrete forward guidance from ECB President Christine Lagarde. Therefore, positioning adjustments could lead to higher-than-expected realized volatility.
Hedge Fund and Real Money Account Positions
Data from the Commodity Futures Trading Commission (CFTC) reveals that hedge funds were nearly neutrally exposed for the week ending October 8. Real money accounts, on the other hand, were still long on the euro, albeit with diminishing conviction. Europe-based interbank traders report that aggregate short-term positioning is around -1.5 on a scale from -5 to +5.
A one-day breakeven for the euro stands at approximately 50 dollar pips, setting a low threshold for surprise if investors opt to rebalance their spot exposure. This could occur even if Lagarde adheres to the script and keeps all options open for the December meeting. A distinctly dovish or hawkish cut is likely to result in wider ranges than anticipated.
Deep Dive Into Markets
As of 7:35am ET, EUR/USD was trading slightly lower at 1.0866. It has declined 1.6% year-to-date and is heading for a third week of losses for the first time since June. Technically, the euro remains within a bullish trend channel that began a year ago, with current support around 1.0770. A short-term MA bearish crossover is negatively impacting sentiment.
Positions for Euro Longs and Bears
Euro longs need mean reversion to take over and 1.0835, the 61.8% Fibonacci retracement of gains since mid-April, to hold on a closing basis. Euro bears are targeting a move to the August 1 low at 1.0778, which could result in a profit-taking bias.
Overnight volatility is trading at 9.75% for a breakeven of around 50 dollar pips. One-week 25d risk reversals are trading at 32 basis points, puts over calls, and are in consolidation mode this week. Downside exposure trades at a premium across tenors, which widens as one moves further out the curve.
Large expiries on Thursday include 1.0800 (€988m) and 1.0975 (€914m): DTCC. According to traders in Europe, interbank desks have shifted into sell-the-rally mode this month, while fast money enters the decision long the greenback. Real money names still hold on longs.
Bottom Line
The upcoming ECB meeting is expected to result in the third interest rate cut this year, a move that could have significant implications for the euro and the wider economy. Market watchers will be keenly observing the meeting's outcome and the subsequent market reactions. What are your thoughts on this anticipated move by the ECB? Feel free to share this article with your friends and engage in the discussion. Don't forget to sign up for the Daily Briefing, which is available every day at 6pm.
