August has been a bullish month for the euro which has, almost silently, headed north, hitting 1.26 against the US dollar late last week and recovering from a cold bath in 1.20’s water. Even though Mario Draghi has been accused of giving out false expectations about possible ECB intervention in debt markets, investors remain optimistic about the future, still believing the ECB will act soon to protect the euro. As the date for the next scheduled ECB meeting approaches, investors are now preparing for the next stage of the Eurozone “show”.
If we look at the EUR/USD chart for the last month, we clearly see an uptrend since August 2, the date when the last ECB meeting occurred. Investors were in fact disappointed at that meeting as they were eagerly waiting for Draghi to announce a bond-buying program which he hinted at the week before. In the end, the bazooka was not produced and he simply said that the ECB would step in to defend the Euro when needed. The Euro was severely punished during that session. Volatility picked up and disappointed investors quickly sold their Euro holdings. After more carefully evaluating Draghi’s words, investors changed their minds and, with the tailwind of a bullish month for equities, the Euro headed north from around 1.2130 to near 1.2600. That was quite a rise for a low volatile, tranquil month.
It is also apparent that the Federal Reserve has been helping the Euro by keeping investors’ minds occupied with the tantalization that QE3 is to be unfolded soon but, even when QE3 was downplayed by the Philadelphia regional FED’s President Bollard just last week, the Euro stayed firm above the 1.25 handle signaling that the continued Eurozone optimism over expectations of decisive action is still playing an important role.
A few days ago, a rumour grew that the ECB was planning immediate intervention in the debt markets. An anonymous source quoted by Reuters stated the ECB is considering setting a yield target for the debt from Eurozone member countries. Basically, they want to set a cap on government yields and provide the market with the necessary liquidity to keep it tight, by buying sovereign debt, similarly to what the Swiss National Bank has been doing with the EUR/CHF. Although, being just a rumour, with many open questions,the mere possibility of the ECB providing liquidity through a bond-buying program is widely seen as a very supportive move. It may be the case that investors are again setting themselves up for disappointment on September 6 when the ECB meets again? Market positioning in the euro is also leaning towards a renewed fall as extensive short covering has taken place this last month.
Given current Eurozone political constraints and scrutinising Draghi’s words during the last ECB meeting, it does not seem the ECB would just jump into the debt markets with unlimited funds without any commitment from the involved governments. As Draghi stated, countries experiencing difficulties need to first ask for help from the EFSF / ESM and then commit to its rules. An adjustment plan with accompanying austerity measures would always need to be implemented before the ECB jumps in, otherwise the ECB would be monetising debt in the same vein as the US, Japan & the UK. Debt monetization is anathema to the Germans in particular and is not part of of the ECB mandate
So September 6 is the date when Draghi will unveil its plans to save the Euro (or not), but he will still have a thorn in his shoe at that date. September 12 is the due date for a ruling on the European Stability Mechanism by the German constitutional court. The ECB may want to wait until that decision is known before unveiling its plans. That means that September 6 may be a disappointment to many. Euro bulls should tread with caution here.
Filipe R Costa & Editor