For the past two years, many investors were betting against the Euro, estimating the Euro to drop below parity. Of course, its near that level, but we never saw that level yet. This is even though the Federal Reserve raised rates twice and the ECB launched QE.

Why the Euro Is Strong Above 1.04

Since the currency market is always pricing future expectations, traders need to keep an eye on possible policy changes by the ECB.

In the past two decisions by the ECB, Mario Draghi noted that they are planning to start tapering the current QE program in April. In theory, the ECB will increase the money supply. Its balance sheet will continue to expand, which is supposed to be a negative factor for the Euro. Then, why the Euro is still strong?

It's true that the ECB balance sheet will continue to expand. But what matters here is that the expansion will be in a slower pace.

Economic Outlook Has Improved

In the past two months, anyone following the European inflation data in addition to the economic activities have noticed the notable improvement. But the focus for the time being is inflation. Almost all the Euro area countries reported a higher inflation in the past two months.

The ECB main objective is to insure price stability. Higher inflation means that the bank needs to ease the stimulus package. Also, if needed, they may raise rates. However, this is still early to judge. Yet, the latest data encouraged the ECB to announce a plan to end the ongoing QE.

Another Catalyst

The new president of the United States also has a role in this. Last week he noted that the US Dollar is too strong and its “killing us”. This was one of the main reasons behind last week's selloff, the Euro managed to end the week above 1.0680’s. With Trump looking to cap the US Dollar gains and/or to start another currency wars, this would ease the chances for a stronger dollar ahead.

What Happens Next?

Since the ECB is planning to stop its QE program, the market will keep on pricing in this event in advance. Until when? Until things changes whether by the ECB or by the Fed.

The most important factor in today’s situation that the ECB might be able to unwind its balance sheet before the Federal Reserve, which would be another positive factor for the Euro. This is exactly like what happened before when the ECB shrank its balance sheet after the EU debt crises.

Its also the same as what happened to the US Dollar for the past two years. The US Dollar started trending higher, when the Federal Reserve hinted for tapering its open-ended QE. Since then, the US Dollar has been rising on the estimates for higher rates in the future. Even though the Fed raised the Fed rate twice, the US Dollar gains were limited. This is because the market has already priced in the decision in advance. Nowadays, investors are doing the same. Pricing in the ECB tapering in advance and higher rates in the future. This might grant a bottom in the Euro soon.