EUR/USD Found A Base, Draghi To Meet Expectations This Week

European officials turned the tide in market sentiments last week. The Spanish 10-year yield reached a new record high at 7.751% and just as it looked like yield is heading to 8%, ECB President Draghi stepped in with a strong pledge and turned things around. Spanish 10-year yield closed at 6.744%, a full percent below the historical high and is now below the 7% unsustainable level. Italian 10-year yield also followed and closed at 5.956%, below 6% level. EUR/USD successfully defended 1.2 psychological and reversed. While USD/CHF also reversed ahead of parity. Rally in stocks was equally impressive as Dow broke through 13000 psychological level to close the week at 13075 and is set to take on 13297 2012 high next.

Technically, EUR/USD should have at least made a short term bottom at 1.2042 and 1.2 looks safe for near term. GBP/USD also look set to head back to 1.59. USD/CAD's fall now opened up deeper decline through parity. Meanwhile, AUD/USD extended is rally and is heading back to 1.07. Yen crosses, including EUR/JPY and GBP/JPY should have bottomed in near-term too and more upside is anticipated. Nonetheless, note that firstly, EUR/GBP's recovery last week looks corrective and we're still bearish on the cross.A similar picture is seen in EUR/CAD and there is no change in the near-term bearish outlook in the cross. EUR/AUD's price actions also look corrective and indeed, steep selling was seen before the week close. We stay bearish in EUR/AUD and expect a revisit of 1.1694 low soon.

Meanwhile, the Dow's strong rise last week firstly ruled out a head and shoulder top (or triple top) scenario. And risk markets are set to continue, with the Dow heading back to 13297 high. S&P 500 is also seen heading back to 1422 high. The Dollar Index's break of 82.73 support confirmed short-term topping. So, based on the overall outlook in different markets, a risk rally will benefit the aussie, Canadian dollar, as well as the sterling. Meanwhile, we'd expect the dollar to stay pressured in the near-term, including against the euro. So, instead of preferring to short EUR/AUD, EUR/CAD and EUR/GBP, we'd now prefer to long AUD/USD, short USD/CAD, and to a lesser extent long GBP/USD.

And to recap, the turn in sentiments started when ECB Governing Council member Nowotny raised the idea of giving ESM a banking license again. In that case, ESM could tap ECB funding which would then increase its firepower tremendously. ECB President Draghi followed by being strict forward that "ECB is ready to do whatever it takes to preserve the euro" and he urged the markets to believe him "it will be enough." Also, he noted that "to the extent that the size of the sovereign premia (borrowing costs) hamper the functioning of the monetary policy transmission channels, they come within our mandate." German Chancellor Merkel and French President Hollande then issued a joint statement saying that both countries are "bound by the deepest duty" to keep the eurozone intact and will do all necessary to preserve the euro.

It's reported that in Draghi's mind, Europe's bailout funds could buy government bonds, in particular Spanish and Italian bonds, on the primary market. While ECB could purchases on the secondary markets. In addition, ECB would consider more LTRO operations as well as more rate cuts. However, it should be noted that Bundesbank poured a degree of cold water onto the idea on Friday and reiterated it's opposition to ECB buying bonds, describing that as "problematic" and "not the most sensible" instrument.

While uncertainty remains, the picture should be cleared shortly. It's reported that Draghi will meet with Bundesbank President Weidmann early this week for negotiation. And, ECB will hold meeting later in the week. Expectation for the post meeting press conference is extremely high this week and Draghi must deliver. So, we'll find out whether a based was formed in EUR/USD very soon.

Also, there are a number of important events this week. FOMC will meet this week and would likely tweak the statement to reflect the deteriorated outlook. The chance of additional easing is low and the Fed could hold its bullets at least until September before releasing its new projections. Nonetheless, we'll also have important data from US including personal income and spending, ISM indices and nonfarm payrolls. BoE will also meet this week and it's likely that the central bank will stand pat. However, last week's release of weaker than expected GDP is raising the odds of additional easing and should BoE act, a rate cut is the more likely result.