EUR USD whipsaws then plunges on mixed to dovish ECB message

The European Central Bank (ECB) issued a somewhat surprising but rather mixed message on Thursday that led to a bit of a tailspin for the euro which quickly transformed into a steep dive for EUR/USD.

The first surprise was that the central bank’s quantitative easing program consisting of extensive bond purchases will be extended for a longer-than-expected nine months – to December of 2017. The second surprise was that a firm date for a “tapering” of those bond purchases from 80 billion euros/month down to 60 billion euros was set for April of 2017.

There are two largely dovish assumptions, however, that contribute to the mixed message of this announcement. First, ECB President Mario Draghi stressed that the lowering of bond purchases in April should not be labeled as “tapering,” since the ECB’s view of tapering would imply a gradual reduction to zero. This, he cautioned, was just not discussed at the meeting. Rather semantically, the April shift was simply a reduction in bond-buying that should not be seen as the start of a tapering-to-zero process. The second assumption is that the extension of QE to the end of 2017 should not be viewed as an end-date to the ECB’s massive bond purchasing program. Rather, QE has simply been extended at least to December 2017.

Though the euro initially rose and equities dropped on the first confirmed hint of QE-tapering, the euro quickly reversed course and plunged against the Fed-driven US dollar as the prospect of substantially longer QE weighed.

On the EUR/USD chart, this was manifested as a brief spike well above the 1.0800 resistance level followed by a sharp downside reversal that, as of this writing, has pushed the currency pair down to around the 1.0600 handle. As mentioned in our earlier analysis, the major 1.0500 support level resides immediately below, and our overall bias remains to the downside considering the continuing divergent policies between the Fed and ECB, and especially with rate hike expectations running so high for next week’s Fed decision. In view of this bias, the 1.0500 support level stands as the key downside level to watch, with any sustained breakdown below 1.0500 potentially clearing the way towards a medium-term target at 1.0200.