3 Reasons Why Trichet’s “Strong Vigilance” Didn’t Work

Oh yes he did! As markets had expected, European Central Bank President Jean Claude Trichet uttered the words “strong vigilance” and “inflation” in one sentence. Heck, he all but said that the ECB would raise interest rates in July! So what exactly caused the euro’s sharp fall last week?

1. The hawkish statements were already priced in

One of the most popular speculations for the euro’s fall is the good ol’ “buy the rumor, sell the news” principle.

Recall that aside from hawkish expectations from Trichet, rumors of euro zone officials getting closer to solving the Greek debt drama has also accelerated the euro-lovin’. This was probably why the euro bulls pushed EUR/USD to all the way to the 1.4700 area.

As we can see in EUR/USD’s daily chart, the euro had appreciated by 700 pips since it fell to the 1.0400 support in May 23. That’s 700 pips in two weeks!

EUR/USD 700-pip rally

With a strong move like that, it’s no wonder many traders felt the need to take profits once Trichet actually said the magic words. Besides, some analysts were already thinking that Trichet’s “hawkish statements” weren’t so hawkish after all. I mean, he all but announced an interest rate hike in July, but he also kept 2012’s inflation forecasts unchanged, suggesting that the pace of the next interest rate hikes might be slower than markets had priced in.

2. Greek debt concerns resurfaced

Once the dust has settled and the interest rate junkies have already gotten their kicks from Trichet’s speech, markets once again turned its lenses on Greece. Heck, did anyone really expect markets to forget Greece’s ginormous debt problems?

In the latest episode of Greece’s debt drama, Germany’s Finance Minister Wolfgang Schäuble toughened his call for private investors to put in more than just their two cents (euro?) on a possible second bailout for Greece. The proposition didn’t sit well with Trichet, since credit ratings agencies have warned that any non-voluntary participation of private investors would qualify as a default.

Wolfgang Schaeuble

To make matter worse, even Trichet’s proposal has come under attack. A few days ago he suggested that it might be a better idea to encourage Greek debt investors to voluntarily roll over their Greek investment. But with the ECB itself stating that it wouldn’t voluntarily roll over its own Greek bond holdings, the proposition didn’t gain popularity in markets.

Right now analysts aren’t expecting any concrete decision from European officials until the European Union Summit on June 24. In the meantime, the lack of unity among the euro zone leaders is pushing the euro lower in the charts.

3. Risk aversion hit the markets…again

The last and most obvious reason for the euro’s fall is the broad-based risk aversion caused by global economic growth concerns.

After the ridiculously weak NFP and manufacturing figures printed out in the U.S. last week, investors around the globe increasingly got worried that the global economy is in for a “soft patch.” It didn’t help that China, the second largest economy, registered a weaker-than-expected exports growth in May. Lastly, we saw the OPEC’s “worst meeting” on oil quota end in a draw, while data from other major economies like the U.K. and Australia also clocked in weak figures.

So is it time to dump all your euro holdings and start building a zombie-proof house? Maybe not. For one, Trichet DID more or less announce a rate hike next month, and interest rate differentials alone would give lift to the euro. For now, maybe it’s best to adopt the wait-and-see approach until we determine a clear sentiment for on the euro. Or you could get started on that zombie-proof house.

What do you think? Will the euro tank again next week? Give me a shoutout on the box below, or on my Twitter and Facebook pages!