European Central Bank’s Interest Rate Preview

The most important economic event of the fall comes this Thursday. The European Central Bank (ECB) is poised to change the monetary policy for the Eurozone area, with all eyes on the Euro’s reaction.

It’ll be a landmark decision, as the central bank will alter the bond-buying program further. As always, it’ll do it in such a way to please both hawks and doves.

Almost a year ago, in last December, the ECB started a controversial process: scaling down the bond-buying program. To avoid the taper tantrum caused when the Fed began the same program, the ECB vowed to better-communicate its decisions and to exit the stimulus gradually.

It is no wonder, as the Eurozone economies perform better. Negative rates won’t fit the bill anymore.

With PMI’s (Purchasing Managers Index) pointing to stronger growth in both manufacturing and services sector, and with the unemployment rate looking better and better, the hawks in the Governing Council will try to push for a further stimulus reduction. However, if last December was confusing, expect this decision to be the same.

Current ECB Bond-Buying Program

Under the current program, the ECB buys 60 billion Euro worth of bonds each month. It announced the decision in December 2016 when it created much confusion: while it reduced the program from 80 to 60 billion a month, it extended it for a further nine months. Therefore, the question on everyone’s lips was: is the ECB tapering, or not?

Almost nine months later, this Thursday we should see something similar. The market consensus is for the ECB to reduce the bond-buying program with a further 30 billion/month. That’s tapering!

However, the central bank may pull another stunt and extend the horizon for a further nine months or so. As such, instead of abruptly ending the program, the ECB, while tapering, takes the foot off the gas slowly, not to disturb the markets.

As such, both bulls and bears will have something. The first ones will argue that the ECB reduces the stimulus as now they’ll buy fewer bonds. The other ones will say that fewer for longer is still easing and they’ll sell the Euro.

Long story short, expect the market to be volatile surrounding the press conference.

Euro Ahead of the Event

Euro traded in a range ahead of most of the other currencies for the past month or so. The best one to illustrate this is the EURUSD pair: it stays above 1.17, but below 1.19 for the same period.

Technical traders look for the range to break, with probably pending orders on both sides of the market. Fundamental ones, though, will wait to see the ECB decision. Therefore, it is unlikely that the pair will move much until the release.

The other Euro pairs had a similar trajectory. Ranging seems to be the name of the game, with EURGBP. EURAUD and EURJPY leading the way. Not even Mr. Abe’s re-election wasn’t enough to send the JPY pairs higher.

Conclusion

Expect the Euro pairs to range until Thursday’s event, and to break the ranges shortly afterward. The importance of the ECB communication strategy is obvious via the small ranges the Euro pairs held.

Moving forward, as we get closer to the end of year trading, there’s still time for some critical market moves. Market participants have an eye on the U.S. monetary policy too, so ending on the right side of the market may be a bit trickier this year.

US Inflation to Move Markets

After the Non-Farm Payrolls, last Friday showed the U.S. economy lost over 30k jobs, the focus shifts to the new set of economic data: inflation.

This coming Friday the Consumer Price Index (CPI) will show if the recent increase in the Average Hourly Earnings (AHE) translates into higher inflation. If yes, the dollar will be in demand.

However, a miss on the CPI on Friday will put the eventual Fed rate hike on hold.

US Inflation

Fed Minutes to Confirm the Bank’s Hawkish Statement

On Wednesday, the Federal Reserve of the United States will release the minutes corresponding to the previous meeting. Considering how hawkish the Chairwoman Yellen was, I wouldn’t be surprised to see the same message coming around.

It shouldn’t matter much for the dollar. As always, the minutes lag as they refer to something that happened three weeks ago.

In the last years, it became a habit for the Fed to hike rates in December. It did so on the previous two occasions it had.

Expect this 2017 to bring the same decision. And, it is not by chance that the Fed picks such a month.

End of years flows will be most likely gone by the time the decision comes. The market’s volatility will be subdued too.

As such, the current FOMC Minutes release this week will most likely reinforce the Fed’s hawkishness.

Therefore, the market’s attention will shift to the CPI data on Friday. While the actual CPI month over month is expected to show an increase from 0.4% to 0.6%, the Fed doesn’t look at it.

PPI to Offer a Clue

Instead, the Fed considers the Core CPI data as more relevant for the actual inflation. Just to be clear, the core inflation data doesn’t consider the transportation, food and energy prices. They are too volatile, and the Fed tends to focus on the core numbers.

Therefore, the dollar will jump only if the core data will surprise positively. The forecast, however, shows a 0.2% level, a steady one when compared with the September release.

One day earlier, though, we’ll have an educated guess about what the CPI will print. The inflation on the producer side (PPI) will come out.

Typically, if the PPI rises, it is only a matter of time until the CPI will catch up. As such, traders will open positions based on the PPI created expectations.

Inflation as Part of the Mandate

The NFP data last Friday, while disappointing, wasn’t accompanied by an increase in the unemployment rate. This one dipped.

Many voices put the weak number on the back of the three hurricanes that hit the States. They may be right.

In any case, the jobs data is only one part of the Fed’s mandate. The other one, the inflation-related part, is a much tougher one.

To bring inflation below or close to two percent, the Fed must be flexible enough with the rates. In doing that, it will try to have a balanced approach.

Conclusion

Expect the trading week to be a slow one until Friday. Already today the price action was subdued as the United States banks were on holiday.

The EURUSD pair moved in a minimal range, and other currency pairs followed suit too. Look for this environment to change as we go dipper into October trading, with inflation holding the key for the end of the year flows.