Mario Draghi’s Pledge and What It Really Means for the Euro

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.

EUR/USD Daily Chart

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.

3 comments

  1. Kasqade

     I agree with Bear. As a beginner trader, events like these are what scare me the most. Why?

    Before I give my reason, I am assuming some apprehension about the feasibility of a recovery under the current conditions highly untenable. I also suspect there are more bears than bulls under the current situation to add to the credibility to such a statement.

    First is the lack of experience I have in understanding the effect on markets moments like these have. I too saw the markets skyrocket in midday(EUR/USD) and subsequently took a nose dive right after.

    I was looking at my screen and saying “what..the…heck…is…going on?!?!”. It was tempting to enter the trade and “ride the wave” and catch some “first come first serve” profits to be honest. But I didn’t. I was too scared. What scared me was…yes, we know how dire the situation is and how desperate the markets were for ANY kind of good news. But will the “do anything to keep it alive” from Draghi statement be followed by any action? under what scenario or actions is it even feasible? How do you even price such a scenario?

    As I am writing this, one word comes to summing these times:

    Volatile

    I totally appreciate the clarity that Bear was able to bring on this issue and discussing his approach of a straddle. Damn right. Cause in this current market if you don’t have both sides covered…jeez, i don’t even wanna think about it.

    Reply
  2. BearInTheWoods

    Good post.  The fundamentals are being forgotten in the excitement.  I’m cautious about this rally, because I feel expectations have been made very high and it won’t take much to miss them.  I also believe the laws of diminishing returns apply.  That is, unless we see some action is that is all-new, it is more of the same that has been tried before, but wears off.

    My plan to trade this is a straddle play, but I might only straddle to the risk-off side.  I’m a bit worried the good news is already priced in.  Tough one, good luck all!

    Reply
  3. Joshua Pearce Gibson

    There’s an entire laundry list of things that dont jive in Draghi’s ‘pledge-fest’. Here’s my two biggest hangups. 

    Draghi, through saying they would ‘do whatever is necessary’, forgot to mention that Germany already put the kibosh on ECB bond purchases as a bailout mechanism. I reiterate: Merkel & Co. have officially no-go’d ECB bond purchases as a distressed asset.My second issue is the latter half of the main statement: “The ECB is dedicated to doing whatever is necessary to save the Euro, but the ECB cannot replace governmental procedure”.
    ‘Cannot replace governmental procedure.’
    That’s probably the largest, most blatant back door I’ve ever seen built into a political statement. Technically, according to the mountains of paperwork that make up the Euro, ALL financial aspects are governmental procedure. The ECB doesn’t exist as a financial aid institution. That’s what the ESM is for(which, if you’ll remember, Germany also hammered the brakes on until September at the earliest).
    All in all, it’s a rather disappointing circumstance. Seems to have become the general way of things when it comes to the people driving the Euromobile. All talk and no play.

    Reply

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