ECB: To Buy (Bonds) or Not to Buy (Bonds)?

In the last interest rate decision, European Central Bank President Mario Draghi greatly disappointed the markets. Although he reiterated his intention to work with European governments to buy sovereign debt, he did not provide a concrete plan.

This time around, market participants expect “traditional” easing AT THE VERY LEAST. They are anticipating that the central bank will lower the benchmark interest rate to 0.50% from 0.75%. As for the likelihood of unconventional stimulus measures, the possibility is there albeit low.

If you recall, Draghi has previously stated that the ECB would do whatever is necessary to preserve the euro. It was a pretty strong statement that is probably still lingering in everyone’s minds.

Italy and France are also pressuring the ECB to do something about the exorbitantly high borrowing costs for southern euro zone states.

Italian Prime Minister Mario Monti indicated there was no “economic justification” for the high bond yields because Italy has been very diligent implementing economic reform and deficit reduction. French President Francois Hollande echoed Monti’s sentiment and believes that it is the role of EU institutions like the ECB to bring yields down for the responsible nations.

Another major point to consider is that Draghi chose to skip the Jackson Hole Summit that occurred over the weekend. He cited his “heavy workload,” which gave birth to a lot of theories.

The most prominent one that came up was that the ECB was hard at work putting together a bond-buying program. In fact, Spanish and Italian bond yields unexpectedly fell on Tuesday when leaked comments from an ECB closed door meeting suggesting that the central bank was ready to purchase bonds with maturity of up to three years.

Technical View

The fact that EUR/USD has been range-bound between 1.2600 and 1.2500 for the past couple of weeks presents us with an interesting situation… We find ourselves in a position to play a potentially strong breakout!

EUR/USD Daily Chart

The way I see it, we have three potential scenarios with the ECB rate decision acting as a catalyst:

  1. In the unlikely event that Draghi cuts interest rates AND delivers a detailed bond-buying plan, we could see a clean break above 1.2600. But again, keep in mind that policymakers don’t really like committing to detailed promises as they prefer to give themselves leeway in case they need to make changes down the line. If he does announce more purchases, Draghi will probably just roll out an outline rather than a thorough, concrete plan.
  2. If, however, the ECB slashes its minimum bid rate but doesn’t announce new bond purchases (or if it announces new bond purchases but fails to provide details), it could lead EUR/USD to stay within its 100-pip range. The central bank would basically just be fulfilling the market’s expectations.
  3. Last but not least, I think that there’s a chance we’ll see support at 1.2500 finally break down… but the markets will have to be severely disappointed to achieve that! Draghi will probably have to announce no rate cuts and say the exact same thing as he did in the last ECB rate decision to get EUR/USD back down below 1.2500.

Let’s wait and see what actually happens!