FxWirePro: Euro bloc reprices in options market ahead of ECB and Italian event risks, Assess more imminent among duos

The ECB to meet on this Thursday, the last but one meeting of 2017 is this week Thursday, 26 October. During the meeting in September, the president Draghi stated that the bulk of the decisions for “recalibrating” or updating the existing asset purchase programme will be announced in October. The updated staff forecasts, including the first for 2020, will not be announced next week but at the final meeting of the year on 14 December.

However, the changes the ECB will announce to its QE programme will be linked to expectations on inflation over the medium-term and the exchange rate. This implicitly means we may get a preview at this week’s meeting of what inflation will look like in three years. In September, inflation was forecast to average just 1.5% in 2019, short of the target.

ECB meeting vol a tad rich, post-ECB forward vol cheap   European event risk is once again in the spotlight in light of the upcoming October ECB meeting and a sharp re-pricing of Italian event risk on the week. Of the two, the ECB is the more immediate but likely less impactful for markets, for two reasons.

First, the Bank’s lean towards a “slower but longer” QE extension, designed to reinforce the low-for-long rates guidance and to avoid the need to change the QE modalities, has become market consensus following recent speeches from Governing Council members.

Heavily overweight long Euro positions have already been cleaned to a significant extent in the past few weeks, hence the marginally dovish ECB tone should neither come as a shock to Euro bulls nor spark any additional material position adjustment on their part. Central banks on a policy normalization trajectory have also proven extremely careful to avoid a repeat of a taper-tantrum like an episode in their bond markets, hence odds of a surprise hawkish delivery from Draghi have fallen as a result.

Second, ECB meetings have not proven to be asymmetric buys over the past five years to inspire confidence as a systematic long.

The above nutshell illustrates that the average ECB day spot moves across the Eurocross universe has by and large been in line with options market pricing, with a small outperformance bias (fat right tail of realized/implied on-day spot moves) only in a subset of crosses such as EURJPY, EURCAD, and EURNOK. Critically, however, a five-year analysis masks the more recent trend of under-delivery on meeting dates.

The above chart plots the close-to-close meeting date absolute spot moves in EUR-crosses as a fraction of the ECB date O/N vol priced into vol curves a week before the event, and shows that the outsized realized vol delivery of the heydays of ECB QE has given way to a far more sedate, well telegraphed (and perhaps more fairly priced) event regime.

The picture does look less lopsided with intra-day high-low spot moves but leaves the broad trend of diminishing returns to ECB event ownership unchanged and in any case such intra-day swings are only monetizable by only a small community of the agilest high-frequency delta-hedgers. Courtesy: JPM