For the investors who are watching the Euro, its latest behavior might appear bewildering. After all, the ECB, slightly undershooting expectations, still increased its target asset purchases to roughly €1.5tn. At the same time, the ECB cut the deposit rate to -0.3%. And let's not forget the goings on over on the other side of the Atlantic. There, the Federal Reserve is gearing towards its first rate hike in almost a decade. What, then, could possibly incentivize investors to buy Euros? And can it last?
Draghi's Words Hit a Nerve
When investors expect more central bank easing, they also expect the obligatory rhetoric. But what they hate is when the rhetoric is of a very specific sort. In this case, it is when a central banker stresses the limitations of monetary stimulus. Yet, in practically the same breath, they drive home the need for more government input. And essentially, that is exactly what Mario Draghi said.
Now, when the Fed unleashed similar rhetoric, it was seen as a signal that its ammunition might be running out. Earlier this year, the BoJ had made a similar statement in an attempt to lower expectations of more stimulus.
Given that, if Draghi is using that kind of "excuse," what can we presume? Perhaps that Super Mario is actually preparing us for less stimulus? Certainly that makes one think. And the fact that Mario Draghi was rather moderate in adding more stimulus tends to fuel speculation.
Now, what do investors do when they are "underwhelmed" by the stimulus? They liquidate positions first and ask question later. And so the EUR/USD bounces back to 1.09 from its lows.
What Drove Draghi to Undershoot?
So what drove Draghi to backpedal on the buildup he created coming into the December meeting? Though he didn't say it outright, it might just be the same reason the other central banks chose. That is to sit back, wait, and see how it all plays out.
Because that is exactly what Draghi wants—to wait and see. Draghi might presume that a Fed rate hike is coming this week and that that might weaken the Euro. If so, that could stimulate the Eurozone economy a bit. If that's the case then why not save his weapons for later?
The second reason, perhaps, is rooted in the chart below as prepared by the ECB. The chart illustrates the growth in money flows in the Eurozone (M3). As can be seen, the drag to M3 Money Supply from a shrinking credit market has eased. In other words, the Eurozone credit market is no longer contracting. And that means deflationary pressures might ease as well. Which, of course, just might validate Draghi’s wait-and-see approach.
Chart courtesy of The ECB
Draghi will have to deliver
In the end, however, Draghi will still need to unleash another QE bazooka. Because, despite all else, there's a big difference between loans that stop shrinking and loans that grow robustly. And, of course, under such a case, Eurozone inflation is likely to stay muted. And since inflation will be well below the ECB's 2% target Draghi will be compelled to act.
Euro Strength Transitory
It is quite the paradox but the longer Draghi waits with additional stimulus, the longer the Euro will be lower. The Eurozone needs a Euro that is lower than $1 to recover and boost its exports and inflation Otherwise the economy will just barely muddle through.
Don't be fooled by appearances, the Euro, despite its plunge of 25% since May last year, is still overvalued and weighs on regional growth. And since that is the case, the latest Euro strength then is nothing more than a pause before the fall. In other words, the Euro's appreciation is transitory in nature. Short sellers of the EUR/USD might soon come down from the fence and pile on for another short. But, this time, it could be all the way to parity.
Look for my post next week.
INO.com Contributor - Forex
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.