Draghi Will Have a Lot of Explaining To Do

Draghi Will Have a Lot of Explaining To Do

What a difference a day makes!!  One day after investors seemed as if they couldn’t get enough of the EUR yesterday morning after comments from ECB President Draghi to the European Parliament that the central bank would be happy to buy bonds with maturities up to 3 years, the market has completely reversed falling to a low of just above 1.2500.

Everything seemed set yesterday for the EUR to continue a rally through the 1.2630 level, but by the time the North American trading session began, the EUR started moving lower and continued to do that all through yesterday and during trading overnight.

Guest post by  Matthew Lifson, Foreign Exchange Trader,  Market Analyst of  Cambridge Mercantile Group.

Apparently the notion of the three year bond purchase may be “illegal” in terms of the treaties that have been set up for the creation of the EUR.  Furthermore, there is concern that certain governments may be tempted to raise the amounts of short-dated funds that they borrow.

It seems that ECB President Draghi will have a lot of explaining to do on Thursday after the ECB meeting and traders are becoming wary that he won’t be able to deliver on the promises that have been made over the last few weeks.

Before the press conference tomorrow the ECB will actually meet and analysts expect that the central bank will lower rates 25 bps to 0.5% from 0.75%.  While all eyes will be on the press conference to hear of the plans that Draghi should be revealing, he may disappoint the masses and delay releasing details of any bond buying plan until after September 12, when the German Constitutional Court will rule on the legality of the European Stability Mechanism.

It would seem difficult for the ECB to deliver a plan that may not fly is the German Court rules against the ESM.  Odds are that this will not happen, but it is a possibility and that would create a terrible embarrassment for the ECB.

Adding to the EUR woes are the was release of the Markit and German PMI for August. Markit number fell 47.2 in August after a preliminary reading of 47.5.  Analysts had expected no change.  German service sector contrasted at its fastest rate in 3 years with PMI coming in at 48.3  A reading above 50 indicates expansion, a number below contraction.

In other currencies the Australian Dollar fell below the 1.0200 support level after growth slowed more than expected.  The Australian economy expanded 0.6% in the second quarter, after growth of 1.4% during the first quarter.  Surveys had expected growth of 0.7%.

The Bank of Canada will make its interest rate announcement this morning.  All analysts expect the central bank to keep rates steady at 1.0%.  While most central banks seem to be looking at monetary easing, the BOC should continue to mention monetary tightening in its statement if economic developments justify that move.

Given the movement in the last 24 hours it is evident the market is confused.  While it seems they want to believe in the EUR as evidenced by the move early yesterday, past failures by the ECB have traders wary of buying the EUR.  SInce there is no way to know how the German Court will vote next week, it has become more likely that the statement given tomorrow after the meeting will not be what many had hoped for.

EUR has held the 1.2500 level today but does feel a little heavy.  While trading should remain light ahead of tomorrow’s events it would seem the market has decided on a wait and see attitude before any further serious EUR buying occurs.

Overnight Asian equities were lower as are most of the European equities this morning and DOW FUtures are lower at 5:00 am indicating a negative start to the US equity markets.

Matthew Lifson

Matthew Lifson

Matthew Lifson is a Foreign Exchange Trader and a Market Analyst. with Cambridge Mercantile Group.