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EURUSD has risen above 1.20 for the first time since January 5, 2015. The combination of ECB-induced EUR strength and substantial headwinds for the USD in the coming weeks pushes EURUSD higher. In the aftermath of the symposium in Jackson Hole at the weekend, EURUSD rose above 1.20 today, for the first time since January 2015. Clearly, one important factor providing impetus for higher EURUSD levels was ECB president Mario Draghi’s reluctance to address recent EUR strength in his Jackson Hole speech.
The market saw this as a sign that current EUR levels do not yet worry Draghi to an extent that justifies immediate verbal intervention.
However, the ECB’s September meeting is coming up next week. The market would see it as a free ticket for further EUR strength if the ECB did not mention the strong EUR on that occasion either.
But, this is unlikely in particular, as the EUR has now appreciated to an extent that should have an impact on ECB’s forecasts (refer above chart). These forecasts are anyway due to be updated at the September meeting, so the meeting provides the ideal opportunity for ECB to discuss the impact of a stronger EUR on growth and inflation and probably also highlight that an appreciating EUR means tightening financial conditions. Draghi pointed out at Jackson Hole that the ECB has not yet seen self-sustained convergence of inflation towards their objective. Further EUR strength complicates this convergence even more, and for this reason, ECB cannot risk EUR appreciation to get out of hand.
Hence, the ECB meeting next Thursday constitutes a substantial event risk that should limit the upside in EURUSD.
Defused bearishness:
EURUSD is consolidating as it is digesting several risks which are thus losing their potential of bearish surprises, limiting the extension of the pullback.
FOMC minutes confirmed the growing expectations of the Fed putting balance sheet reduction ahead of rate hikes in the next few months. This should have much less FX impact than actual Fed Funds hikes.
ECB minutes expressed concerns about “the risk of the FX rate overshooting in the future”.
Draghi stated at the 2014 Jackson Hole event that the ECB was ready to use “all the available instruments” to lift inflation expectations.
Options Strategy:
The EURUSD appreciation has reached newer highs, those who’ve been dubious for further gains and thinks that pace is now going to be slower than it has recently been, and the skew is still undecided whether volatility should rise on the back of a higher or lower spot.
As such, we do not focus on intermediary Vega gains to favor instead a buy-and-hold structure benefiting from the passage of time, as the timing of euro upside is less certain.
Mechanics: Buy EURUSD 3m ladder, strikes 1.19/1.21/1.24 Indicative offer: 0.35% (vs 1.15% for the call strike 1.19 only, spot ref: 1.2051).
Risks profile: The above structure may expose investors to the unlimited risks if the EURUSD trades above 1.2550 at the 3m expiry, a level not seen since end 2014.
