After being shellacked to start the week, the US dollar is being given a small reprieve today as investors await tomorrow’s BOJ and ECB meetings. The US may also report a bounce back in housing starts (residential investment) after a three-month slide.

The euro reached a 14-month high yesterday just shy of $1.1585 as it approaches the 2016 high near $1.1615 and has pulled back today, though remains well within yesterday’s range. There is a 525 mln euro option struck at $1.16 that expires today. Caution ahead of tomorrow’s ECB meeting, in a light news day, seems to be behind the consolidative tone.  

A Reuters report quoted an unnamed official suggesting that the ECB wants to keep the asset purchase commitment open-ended. Many, including ourselves, saw the dropping of the commitment to buy more bonds if necessary as part of the housekeeping that would continue to prepare the market for a September announcement indicating an extension of the balance sheet expansion operation, but at a slower pace. If the report weighed on the euro, there was not much of a reaction in the European bond market, where 10-year yields are narrowly mixed (~+/- 0.5 bp). Two-year yields are little changed but mostly slightly firmer.  

Initial support for the euro is seen near $1.1510 and then $1.1465-$1.1485. Sentiment seems evenly divided between euro bulls, on continued equity flows (valuation) and anticipation that a gradual exit from the unorthodox monetary stance is underway, and dollar bears on a softer policy mix (less Fed tightening and less fiscal accommodation). Our concern is that the market may be exaggerating both sides. The ECB’s normalization will be a protracted process, and besides the tweaking of its forward guidance, its balance sheet is still around a year away from peaking, if as we suspect the asset purchases will continue through H1 18. On the US side of the equation, we continue to expect the Fed to allow its balance sheet to begin shrinking in Q4, and we would not rule out a December rate hike.