Four scenarios for markets at July’s ECB meeting

We see the two-step post-French elections EUR/USD rally as fully justified starting with a build-up of QE taper expectations, amplified by Draghi’s Sintra speech, mainly driven by steeper German yield curve. It seems it will only be a matter of time before EUR/USD breaks through 1.15 (as bund yields nudge up), with an overshoot around the ECB September meeting.

We see limited scope for lower Eurozone sovereign yields. While the ECB wants to avoid a taper tantrum bund sell-off, it also seeks to pre-prepare the market for eventual QE tapering via gradually higher yields. Thus, a dovish surprise and sharp decline in bund yields is not desirable. The likely retention of the QE easing bias (the threat of an increase in QE duration and size) may push German 10-year yields lower, but don’t expect a material move below 0.55%. We could see German yields rise hit 0.65% later this year.