By Nick Kalivas
Wed 05 Sep 2012 08:45:16 CT
The FX market will focus on the ECB meeting tomorrow and the outlook for the ECB to purchase short term notes in the peripheral of the EZ. Most in the trade seem to be looking for a 25 bps rate cut at tomorrow's meeting. However, media reports this morning suggest that the ECB is ready to make unlimited, but sterilized note purchases which do not target yields. The idea that the ECB will sterilize its purchases could cap the expansion of its balance sheet, which has risen by slightly less than 50% over the last year. This may be supportive to the euro currency by limiting the supply of euros and attracting capital to peripheral debt markets. As the graphic displays, the EUR/USD rate has tended to follow the direction of relative balance sheet expansion between the Fed and ECB in recent months. When the ECB's balance sheet expands (contracts) relative to the Fed's balance sheet, the dollar firms (weakens). It is debatable as to whether the ECB could fully sterilize large debt buying operations, but the idea is consistent with pleasing opposition within the ECB to a debt buying program, and could also put a greater spot light on Fed policy. An asset purchase program by the Fed could lift the Fed's balance sheet at a time when the ECB's balance sheet is relatively steady. The markets continue to debate the outlook for the Fed to implement "QE3" due to a high U.S. unemployment rate.
The policy action by the ECB is important given the positioning in the euro currency. As last week's commitment data illustrated, non-commercial traders (a proxy for large funds) were short 147,648 and long 43,671 futures and option contracts. There appeared to be a lopsided short through August 28th. The data also showed non-commercial traders net short covering about 22,600 contracts in the last reporting week. The recent rally in the euro currency has been squeezing shorts.
Those analyzing the December euro currency chart might eye the ability of prices to work over the recent high at 1.2652 and 6/29 high at 1.2710 for signs of strength. A break below the low from 8/28 at 1.2484 and high from 8/6 at 1.2456 could be viewed as a sign of weakness.
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