It seems the ECB has come out on the offensive in recent days, causing a sizeable short-covering rally in many different asset classes.
Yesterday we mentioned comments from Ewald Nowotny, and subsequently it was the ECB President’s turn to install modest confidence. Mario Draghi said at a speech in London ‘to the extent that the size of these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate.
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro’; he then added ‘believe me, it will be enough.’ It was perhaps the determination in his voice that really scared euro shorts off, and left most in the market wondering what exactly they are likely to do. It seems most now believe they will resume buying bonds in the secondary market under their SMP (Securities Market Programme), with the idea to bring down yields. The result was a huge decline in Spanish and Italian yields, which subsequently saw EUR/JPY push up to 96.43 and EUR/USD to 1.2330. Given the dynamic nature of the forex market, it requires traders to act nimbly and this is clearly the case with the euro, which is why we always trade with stops. Having started the week with a bearish bias on EUR/JPY, we have now moved to the side lines, having a more neutral bias on the pair.
We also know that the ECB will have to deliver at its central bank meeting next week. Simply cutting its refinancing rate is not going to cut the mustard; it will need to announce something more substantial, or the euro runs the risk of getting smashed. We feel that the ECB has done a good job in diverting the attention away from the euro side of the EUR/USD equation, and the focus now falls on the USD. In US trade we get Q2 GDP (consensus is 1.4%) and core PCE (consensus 1.8%), where any readings below consensus will feed into a weaker USD, especially given we have the FOMC meeting next week. We even feel there could be scope for further upside in EUR/USD, but would feel more confident in suggesting long EUR/USD on a close above the July 19 high of 1.2324.