26.10.201803:55 Forex Analysis & Reviews: The euro collapsed - but selling EUR/USD is risky now

Today, the European currency showed increased volatility in response to the results of the October meeting of the ECB. On the eve of this meeting, or rather a few hours before it, the euro-dollar pair suddenly returned to the 14th figure. The reason for this movement was market rumors, according to which the European Central Bank will maintain the course of normalization of monetary policy, despite the complex problems of both macroeconomic and political nature (weak inflation and the Italian budget issue).

Moreover, the first results of the meeting were also very optimistic: the regulator noted that the risks to economic growth are generally balanced (despite Brexit and Italy), and inflation will still reach the target level, despite the September slowdown. In addition, Mario Draghi stressed that the average wage is growing, and this fact is not temporary or seasonal. Draghi also commented on the dynamics of core inflation. Let me remind you that this indicator fell back to 0.9%, although most experts predicted an increase to 1.1%. The head of the central bank was not baffled by this fact – he said that the core inflation index should accelerate by the end of this year and will gradually grow in the medium term.

Draghi expressed similar optimism about the labor market in the EU - he noted a decrease in unemployment and an increase in the number of employees, while the already mentioned wage growth only added to the positive picture. Contrary to forecasts, he did not focus on yesterday's release of PMI indices in the manufacturing sector of Europe, simply ignoring this fact. His overall assessment was positive, especially with regard to the growth prospects of inflation indicators. Therefore, it is logical for the EUR/USD to jump to 1.1430 after the beginning of the Draghi press conference. However, the bulls of the pair failed to consolidate the success – an hour later the price collapsed to multi-month lows.

Oddly enough, the reason for the decline of the euro was Italy. Despite the fact that Draghi initially expressed confidence that Brussels and Rome will agree, he later on somewhat changed the tone of rhetoric. First, he said that, in his opinion, "the monetary union remains fragile." Although the Italian authorities have repeatedly stated that they do not intend to leave the eurozone, some politicians of this country still voice such slogans – and they have some success with the population. The budget crisis only strengthens anti-European sentiment in Italy, and politicians are forced to follow the electorate's opinion. However, Mario Draghi did not decipher his thought – but the very fact that he doubted the "longevity" of the eurozone provoked selling of the single currency.

Furthermore ,the ECB head told reporters that the European regulator will not provide "mediation" in the conflict between Rome and Brussels, but would act in accordance with EU regulations. The hint is quite transparent, given the recent rumors about the ECB's position in the"Italian confrontation". According to one of the news agencies, the regulator will not, if necessary, provide assistance to Rome – until the Italians reach an agreement with Brussels. If a compromise is reached, the European Central Bank can buy Italian government bonds through outright monetary transactions ("direct money transactions"), thus saving the banking sector from collapse.

Here it is worth noting that, on the one hand, the Italians have already abandoned such a scenario, but, on the other hand, the cost of borrowing in the debt market is growing significantly. The spread between the yields of ten-year Italian government bonds and those of German bonds is at five-year highs. According to experts, if this trend continues, the Italian banking system may not withstand the pressure. And given, the hypothetical refusal of assistance from Brussels (on the terms of the EU, of course), a very grim outlook emerges that could turn into a large-scale crisis.

Building such a logical chain, traders were in a hurry to get rid of the European currency, despite Mario Draghi's previous optimism. The head of the ECB, perhaps unwittingly, focused the market's attention on the Italian problem, which may well provoke more global problems, not only of an economic but also of a political nature – if in Italy it comes to re-elections. Italexit's shadow loomed again in the market, after which the demand for the euro fell predictably.

Despite the fact that the euro-dollar pair might reach the annual lowest level (1.1298) in the near future, long positions still look risky. Today's trading day eloquently demonstrated the importance of the Italian question. In fact, it was only because of Italy that the pair collapsed to the indicated low prices. All other factors (mainly macroeconomic) play in favor of the euro - as well as the position of the ECB regarding the prospects of the European economy. This situation carries a risk: after all, the Italians should come to an agreement with Brussels (and this scenario cannot be ruled out), the bears of the EUR/USD will not have clear arguments to keep the price at such low values.