Thursday, October 29, 2020

A surge in Covid-19 cases renders the ECB’s earlier assumptions for the virus out of date

  • Dollar
  • Euro
  • European Central Bank


Analysts’ Pick: A surge in Covid-19 cases renders the ECB’s earlier assumptions for the virus out of date

  • ECB looks set to eventually expand asset purchases, but may hold off on that for later meetings in favour of sending explicit forward guidance to markets today
  • EUR/USD may be set up for some temporary downside on the decision as a result, but expect volatility to play a large role in price action today as we come off the back of a heavy selloff in equities yesterday
  • In the medium term, we expect the euro to underperform most of its G10 peers, but downside for EUR/USD may be limited due to a potentially weaker dollar in most probable outcomes in the US elections

While elections and the rout in equity markets last night was the main focus of headlines today, increasing number of factors point to a temporary downtick in the euro in the short-term as we expect a higher likelihood for at the very least, additional dovishness from the European Central Bank (ECB) at its decision later today. Germany and France have imposed stricter restrictions within their respective countries to help curb the spread of the virus, something that markets would have probably expected since at least a week ago following the uptick in Covid-19 cases across member countries. In economic terms, this should be more worrying for the ECB as its initial assumption’s published earlier in September that the virus remains under control is looking very much outdated at this point in time. Additionally, the peak in alternative mobility-focused data compiled by Bloomberg before the reintroduction of heavier restrictions imply that more damage is likely to come.

EU countries show no sign of deceleration in daily Covid-19 cases yet, signalling that there may be more restrictions to come in the short-term


While the economic environment is set up for the ECB to ease further, a high ceiling to its Pandemic Emergency Purchase Programme (PEPP) suggests that it is more likely that any expansion to asset purchases may only come at the end of 2020, or early 2021. Additionally, with the shuttering of restaurants and bars in Germany and France as well as other restrictions across the euro-area, the ECB may well decide to extend the timeframe of the PEPP from mid-2021 to end 2021. This will likely give European governments more flexibility since fiscal spending may see another step up in light of the newly imposed restrictions.

Alternative data implied economic activity in EU hit a plateau in August, and is now starting to converge below that of a weighted average index of advanced economies


In our view, the above sets up the ECB for at least a switch in tone. ECB President Christine Lagarde's tone has already moved away from the more optimistic one she had at the post-monetary policy meeting press conference back in September, and we expect nothing short of dovishness from the central banker during today's press conference. Also, we previously reported that the meeting minutes showed officials more cautious than optimistic during last September's meeting as well, which probably will mean that today's opening statement will likely note that downside risks are starting to materialising and may provide more explicit forward guidance in regards to signals for a possible expansion of asset purchases in coming months. This should provide the euro with some temporary downside pressure on the release of the statement, and again during Lagarde's post-meeting press conference after.

As a result, we expect to see some additional downside for EUR/USD today closer towards 1.1702's level on the central bank's decision. That being said, we view volatility resulting from resurfacing Covid-19 concerns and the US election to be considerable risks that may consequently limit downside for this particular currency pair. The same can be said for our medium-term outlook for the currency pair, since while the euro is expected to underperform most of its G10 peers excluding sterling due to another potential easing cycle from the ECB and weakening economic outlook due to the surge in Covid-19 cases, downside against the greenback could be limited by a weaker dollar as well. Our expectations for a weaker dollar are due to the post-election economic outlook appearing to be conditions more positioned for a downward trend in the greenback for most expected outcomes (outcomes that will likely result in a stronger dollar is a Republican controlled Senate and the small probability for a non-peaceful transfer of power).

Technical Analysis:


EUR/USD has effectively been range bound in the last three months. We don’t expect strong changes in the short-term due to the uncertainty in political backdrop in addition to new developments in the euro area with regards to Covid-19 infections. That said, we view that there may be some room for the euro to drop on downward momentum in the short-term as bears continue to apply pressure on the currency pair to take it closer to 1.1702. We don’t expect much downside from that level due to the proximity of RSI to oversold levels as well as general support at current MACD levels. In the medium-term it does appear that the EUR/USD pair will probably continues to trade in a medium-term uptrend, rationalised by a potentially weaker dollar. A probable easing cycle from the ECB may weaken this, but we view that decision to unlikely be the catalyst for a downward spiral past the 200-day moving average.

Support: 1.1702 / 1.1611 / 1.1472

Resistance: 1.1804 / 1.1900 / 1.2012

EUR/USD Chart (H4)