(This is an excerpt from an article I originally published on Seeking Alpha on December 7, 2015. Click here to read the entire piece.)
Mario Draghi, President of the European Central Bank (ECB), apparently decided not to follow the now well-established playbook for steering markets nearly perfected by the Federal Reserve:
- Guide the market to where you want it to go.
- Pay attention to the market’s expectations.
- Follow-through by implementing at a minimum what the market expects.
Instead, not only did the ECB roll out its latest pronouncements (December 3, 2015) on monetary policy far short of market expectations, but also the ECB used the weeks before the quiet period going into the meeting to reassure markets that something bigger and juicier was on its way. With shorts piled into the euro (FXE) at levels last seen in March of this year, the impact of the disappointment was immediate and severe. Draghi gave markets a full drubbing. (Many major European stock indices also lost 2% and more on that day).
Source: FreeStockCharts.com
The small irony of this drubbing is that the resurgence in the euro gives an easier path ahead for the Federal Reserve to finally hike rates on December 16th. {snip}
As the chart of EUR/USD above shows, the drubbing was significant, but it failed to break through the key resistance level at the 50-day moving average (DMA). With shorts in retreat and market confidence shattered, I think the path of least resistance is up for the immediate short-term. Perhaps EUR/USD even hits 1.10 ahead of the Fed meeting. {snip}
The swiftness of this move was far greater than anything I had imagined when I drew out my plan to “tiptoe” around the euro. So, my response function below is somewhat modified from my original plan – thank goodness I went into the meeting with just a small net short position.
{snip}
So what made this latest ECB meeting such a disaster for anti-euro bets? The clues come from the Q&A session during the ECB’s press conference. Members of the press kept nudging and then pushed Draghi for answers as to how the market could be so thoroughly disappointed with the ECB’s guidance. {snip}
Since at this stage in the game the exchange rate weighs so heavily on the ECB’s policy objectives, the euro acts as a sufficient expression of the success or failure of the ECB’s tools. Currency traders should find this proxy particularly important. The ECB’s policy objectives, probably through at least 2017 it seems, cannot be met with an increasing euro.
Be careful out there!
Full disclosure: net short the euro, long FXE call options
(This is an excerpt from an article I originally published on Seeking Alpha on December 7, 2015. Click here to read the entire piece.)