The euro peaked a month ago near $1.2090. It recorded a low near $1.1670 after the weather-skewed US jobs data seen at the end of last week. The euro recovered from the weekend and set new session highs late US dealings. That reversal pattern marks the end of the month-long decline. 

There has been follow-through euro buying this week, and the euro is approaching the 38.2% retracement objective of the decline since early September. It is found near $1.1830, near the 20-day moving average (~$1.1835), which the euro has not closed above since since September 22. The 50% retracement is near $1.1880.

What concerns us is that the dollar’s rally coincided with heightened expectations of a Fed hike in December, and a rate hike has now been nearly fully discounted. The implied yield on the December Fed funds contract is 1.265%. In our work, assuming no chance of a November move, a 25 bp rate hike at the December meeting, and that effective Fed funds rate falls 10 bp, as it has been doing at the end of a quarter, at the end of December, fair value is near 1.29%. It so happens too, that the US 10-year yield rose to 2.40%, which is the upper end of its six-month range.

The good news has been priced in for the dollar and yields and keeping in mind the technical considerations; the risk is of a corrective phase.  Also, the ECB meets on October 26. This is an important meeting. The ECB is expected to announce its plans for its asset purchase program. The current commitment expires at the end of the year.

With the highest confidence, we can say that the ECB’s purchases will not stop cold at the end of the year. They will continue, even as the Fed’s balance sheet begins to shrink. The main focus is on the trade-off between the length of the program (duration) and the size (of the monthly purchases. Our insight that policymakers see this as a trade-off has now been underscored by the ECB’s chief economist. There is increased talk of a large cut in monthly purchases and extending the program well into next year (more than six months).