EURUSD EYES UPCOMING ECB & FED RATE REVIEWS

EURUSD overnight implied volatility skyrockets to its highest reading of the year ahead of Thursday’s July ECB meeting

EURUSD risk reversals are turning less positive and indicates growing demand for downside protection by forex traders

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Earlier this month, we highlighted how EURUSD implied volatility sunk to multi-year lows, which appeared to be a stark underpricing by currency option traders. Forex volatility is starting to show signs of coming back to life, however, and the July ECB Meeting could serve as a catalyst that propels currency price action further. In fact, overnight EURUSD implied volatility just skyrocketed to its highest reading of the year at 13.34%, which reflects the heightened level of uncertainty and risk attributed to the ECB’s upcoming monetary policy decision by forex traders.

EURUSD IMPLIED VOLATILITY JUMPS ON CENTRAL BANK POLICY UNCERTAINTY

Aside from the upcoming ECB meeting, several other event risks listed on the economic calendar like Friday’s US GDP data and next Wednesday’s release of Eurozone GDP numbers in addition to the July Fed meeting all threaten to stoke additional volatility in spot EURUSD.

That said, market expectations for the ECB to cut rates this Thursday are near split according to overnight swaps pricing. Interest rate traders are indicating a 62.1% probability the central bank’s key rate is left unchanged at -0.4% whereas the probability of a 10-basis point rate cut stands at 37.9%. This is down slightly from a 51.2% chance of a rate cut priced by markets this past Friday when we drew attention Euro implied volatility spiking headed into the July ECB meeting.

ECB RATE CUT PROBABILITY CHART - JULY 2019 MEETING

Regardless if the ECB stands firm on rates or not tomorrow when it releases its press statement at 11:45 GMT, the US Dollar stands to gain against the Euro if ECB President Mario Draghi paves the path for fresh monetary stimulus to stymie further deterioration in the Eurozone economy. Moreover, the IMF cut GDP outlook again for Germany – the EU’s economic backbone – down to a paltry 0.7% growth rate for this year. As such, spot EURUSD could fall even in the shadow of an expected rate cut from Fed Chair Jerome Powell and the FOMC next week.

EURUSD 25 DELTA RISK REVERSAL CHART

Bias to the downside is also supported by the steady decline in EURUSD risk reversals turning less positive. In other words, demand for downside protection is outweighing demand for upside protection. Yet, 71.9% of retail traders remain net-long spot EURUSD according to IG Client Sentiment data.

EURUSD PRICE CHART: DAILY TIME FRAME (JANUARY 07, 2019 TO JULY 24, 2019)

Judging by EURUSD overnight implied volatility of 12.0%, the 1-standard deviation trading range for spot prices is calculated as 1.1066-1.1206 and reflects a 68 percent confidence interval. If the ECB does shock forex traders with more dovishness, spot EURUSD bears could target the 1.1100 handle near the currency pair’s year-to-date low and is a level that could soften a selloff before approaching the lower bound of the option implied trading range. Conversely, spot EURUSD upside might be sparked from a firm stance by the ECB and relatively hawkish rhetoric. In this scenario, the Euro could rise into confluent resistance around he 1.1200 handle.

-- Written by Rich Dvorak, Junior Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight