Will Super Mario be able to save the EURO?

Is this it? Are we finally going to get what we have been speculating for some time or will Draghi fall on his sword as his own credibility gets tested in a few hours? Investors are hoping that Super Mario will deliver on his promise to save the EUR. A new bond purchase program to help bring down borrowing costs for the peripheries, specifically Spain and Italy, is vital for buying respective governments time to come up with a longer term solution to the Euro-zone debt crisis. It is also understood that the markets want the ECB to drop its preferred creditor status. The whispers so far on the street this morning is that the ECB is here to play ball. Mind you this would not be the first time that policy makers have led us astray. At best, the market is speculating that Draghi’s speech and Q&A should be somewhat market neutral. The real fun would be if Germany remains uncompromising.

FX players will need to fine tune their performance this morning. They will be required to balance the EUR positive aspects of any additional stress relief in sovereign markets with the EUR negative affect of any further monetary policy easing. The obvious winning formulae for the single currency would be policy makers ability to drive a further rally in peripheral sovereign bonds (lower yields) without delivering additional monetary accommodation. Obviously the nightmare outcome for Draghi and company is the reverse, where they deliver an easing policy accompanied by renewed deterioration in sovereign markets (higher yields). The minimum that the ECB is expected to deliver is for a repo cut accompanied by relaxed collateral rules with no new details on bond buying plans. In this scenario, the markets would push for higher yields and massive renewed pressure on the currency.

More of a winning ECB formulae for the single currency would require policy makers to delay cutting rates while at the same time introduce in detail, the maturity and country allocation of a new bond buying program, as well as confirming that this debt buying would not be senior to private sector bondholders. The result should give the market tighter peripheral spread, force a sell off in front-end futures contracts, which would support the EUR through both “risk premium and rate support channels.” In this positive scenario the single unit should underperform higher-beta EM and commodity currencies and we know what happens when if yields do rise.

Before Mario and company come out to play “The Old Lady” or the Bank of England takes center stage. No rate announcement is expected (+0.5%) from Governor King and his asset purchase program is to remain on hold at +GBP375b. All rather boring when compared to the drama at the ECB. The UK’s current round of QE does not finish for another two-months. The previous minutes stated that policy makers required to see the effects of the Funding for Lending Scheme (FLS) before making a decision on the Bank Rate. Despite the rising risk of more easing and a potential ratings downgrade, investors have been a better seller of the EUR cross outright preferring to own GBP as a proxy or reserve alternative to the single currency. Many still consider Cable as the “better alternative of a bad lot.”

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The ECB’s press conference will be the catalyst whether the market fails at or breaks through the EUR downtrend line at 1.2655-65. Technically, the currency is still not in the clear despite the impressive rebound off 1.25. It still has to overcome some resistance of note (June high 1.2748). On the downside, a daily close below the 1.2445 short term uptrend line will alleviate the immediate upside pressure. Many players it seems are happy selling at current market price, playing the percentages of a minor drop with a tight stop loss on top. The danger is that too many are applying the same strategy, weak short always tend to get looked after!

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This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell