Markets are looking forward to a huge liquidity injection tonight. The resulting currency moves may be a little harder to predict, partly because of the wide range of estimates of the size of the program. On balance, the possible outcomes could favour a “SELL” in EUR/AUD.
Tonight, at 11.15 pm AEST, the European Central Bank will announce the results of the 2nd Long Term Re-financing Operation (LTRO). Qualifying European banks may draw down 3 year funds, at the overnight rate (1%). Collateral must be lodged, but the amount each bank can draw down is UNLIMITED.
Under the first LTRO conducted in December, more than 500 banks drew a total of 489 billion EUR. This changed the game in global markets, by largely removing the threat to credit markets posed by the European debt crisis.
Estimates of the size of the second LTRO vary widely – between 200 billion and 1 trillion EUR. Market reactions are more difficult to predict where expectations are so scattered.
Additionally, the Euro poses a conundrum. More liquidity should see a general “risk on” reaction, normally expected to benefit the EUR. However, as this environment is sparked by a huge increase in supply of EUR, it could lead to EUR selling. This makes potential EUR/USD moves difficult to forecast.
What currency pair offers the “right” exposure? One way to trade this situation is to be long a “risk” currency (AUD,CAD,NOK,NZD) against the EUR. I’m looking at the EUR/AUD – here’s the 4 hour chart from the CMC Tracker platform:
There’s possibly a head and shoulders forming here – although a move through the neckline at 1.2430 is required to confirm the pattern. Regardless, this looks like a reversal in the making to me.
Markets could interpret the results of the LTRO either way – a small draw could be negative (not enough liquidity) or positive (bank balance sheets in good shape). Similarly, a large draw might be interpreted as a good liquidity buffer, or a sign of bigger problems with European banks.
Under these scenarios, selling EUR/AUD (sell EUR, buy AUD) offers the exposure I’m seeking – AUD should outperform in a “risk on” environment, and outperform in a “weak Europe” scenario.
The chart also gives me multiple potential trades:
Sell EUR/AUD at current levels, with a stop loss above 1.2526 (the overnight high)
Sell EUR/AUD on a breach of the neckline at 1.2430, with a 25 point trailing stop loss.
A swing trade, selling EUR/AUD at current levels, stop loss above 1.2622 (the week high) targetting levels below 1.2200.