Euro Braces For Impact As The ECB Starts Rate Hike Cycle, Draghi Ponders Fate

The Euro enjoyed a shallow pop in Asia-Pacific trade as natural gas flows resumed along the Nord Stream 1 pipeline connecting Russia and Germany. Markets were worried about the possibility that Moscow would hold hostage critical supply amid its row with the West following the invasion of Ukraine.

Flows were deeply diminished amid the conflict before the pipeline was shut for planned maintenance. Then, delays in bringing it back online triggered recriminations from all sides, with Russia blaming parts vendors in Canada and the Eurozone shouting back at the Kremlin. All this commotion spooked the markets.

The single currency struggled to make lasting headway as it eyed heavy-duty event risk ahead. First, the fate of Italy’s Prime Minister Mario Draghi hangs in the balance after a confidence vote yesterday. Draghi won, but mass abstentions signal he no longer has enough support in the legislature to affect policy. He may resign.

Euro May Slip As The ECB Begins Its Rate Hike Cycle

Political turmoil in the Eurozone’s third-largest economy comes at an inconvenient time: faced with blistering inflation, the European Central Bank (ECB) is due to begin tightening in earnest. A 35bps rate hike is priced in, implying a policy rate -15bps. It is then expected to hit 1 percent by the end of the year.

The run-up to this moment has been rocky. The ECB has scrambled to create a mechanism against “fragmentation” – divergence in bond yields among the currency bloc’s member states – as markets fret that rate hikes will revive debt crisis woes in Southern Europe.

Policymakers’ scheme to address this could be called “Operation Sovereign Twist”, echoing the Fed’s maneuver to remix the maturities of bond holdings on its balance sheet. For the ECB, the effort would similarly reshuffle the sovereign mix of the asset portfolio to boost the share of paper from troubled members.

The central bank has said the anti-fragmentation tool would work by reinvesting proceeds from maturing holdings of higher-grade debt into the purchase of lower-grade alternatives. The cadence at which this can proceed may thus define the pace at which the ECB can tighten, limiting its firepower.

The absence of clear operational details on this and other still-vague aspects of how this program will work might worry markets. So too might soft commitment on the size of hikes beyond today. If the markets sniff out hesitation at the press conference with ECB President Christine Lagardeafter the announcement, the Euro may turn lower.

EUR/USD Technical Analysis

The Euro remains locked in a downtrend against the US Dollar. Prices managed a pop in recent sessions after testing the coveted parity level but sellers may be preparing to recapture the initiative. The appearance of a bearish Dark Cloud Cover candlestick pattern hints a top may be forming. The swing low at 0.9952 marks initial support. Alternatively, breaking above the high at 1.0273 appears to set the stage for an underside retest of the broken range floor at 1.0406.

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Euro vs US Dollar, daily chart