In a surprising turn of events, made a pledge on Thursday that policy makers would do whatever is necessary to preserve the euro. Draghi’s comments seemed to suggest that the ECB would finally intervene in the bond markets of troubled nations, like Italy and Spain, to suppress the astronomically high borrowing costs.
In a surprising turn of events, ECB President Mario Draghi made a pledge on Thursday that policy makers would do whatever is necessary to preserve the euro. Draghi’s comments seemed to suggest that the ECB would finally intervene in the bond markets of troubled nations, like Italy and Spain, to suppress the astronomically high borrowing costs.
As one would expect, Draghi’s remarks shocked the markets to life and triggered a wide-reaching case of risk appetite. Immediately after Draghi had spoken, Spain’s 10-year bond yields dropped below the critical 7% level.
Meanwhile, EUR/USD climbed above 1.2300 after it had hit fresh 2-year lows a few days prior. Other risk currencies also rallied, with GBP /USD surging over 200 pips and AUD/USD rising above the 1.0400 handle.
And who could forget the equity market? The Dow Jones Industrial Average posted a huge 212 point gain while the S&P Index clocked in a 22 point rise. Both indices ended the day 1.6% higher.
After seeing such positive news like this, it’s only natural to think that a major reversal may be in the cards. But the fact of the matter is that Draghi’s words are simply just that–only words. Even though bond purchases are back on the table, Draghi has not outlined any concrete action plans yet, which means the optimism the market is feeling is all based on his word rather than concrete action.
Ask yourselves this: What has changed?
Nothing really. Greece, Spain, and Italy still have the same old problems. The market is just more hopeful, which means the rally we’re seeing is very frail. The second market optimism subsides, risk assets could sell-off again as traders price out their expectations.
Besides, the ECB has already done bond purchases before and it didn’t last long. After spending around 220 billion EUR on government debt, the program was shut down due to strong opposition from Germany. That sets a very bad precedent in case the ECB really does go ahead with bond purchases.
There are other things the ECB could do. If you recall, the ECB just cut rates to 0.75% from 1.00%. Slashing it by another 0.25% in its next meeting is an option. The ECB could also set negative deposit rates to encourage banks to lend out money. After all, the central bank has already lowered the deposit rate to zero.
For now, I see no reason for the overall trend in the euro to truly reverse until Draghi and company makes an actual move or puts something down on paper. The sharp rally we saw could simply be the result of traders taking profit on their short positions, and once the move fizzles out, the bears could jump in again and take the euro to new lows.