Euro skydived to its lowest in more than two years following Draghi press conference yesterday (6/11). In the last one year, the 18-countries currency has fallen almost 15% against US Dollar, and all signs point toward more depreciation.

Euro skydived to its lowest in more than two years following Draghi press conference tonight (6/11). In the last one year, the 18-countries currency has fallen more than 5% against US Dollar, and  all signs point toward more depreciation. Despite of internal discontent, ECB President, Mario Draghi, won over the governing board and they unanimously agreed to broader action if needed.

PerformaCurrency Performance Chart shows that the Euro has dropped more than 5% against US Dollar,
while Japanese Yen has depreciated to almost 15% due to continual stimulus

 

Internal Discontent

On Tuesday, an exclusive report by Reuters suggested that Eurozone chief bankers' discontent against ECB Governor, Mario Draghi, has compounded. Again and again, the ex-Italian central bank chief neglected its peers on many moves that heavily influenced the deflation-threatened area. The report drove EUR/USD higher for a while as market players guessed that it will be more difficult for ECB to do more.

It is already common knowledge that Mario Draghi fights a difficult battle against Bundesbank in order to launch ECB asset-buying program. The Bundesbank is certainly not going to agree to anything like US the Fed's Quantitative Easing. To make matters worse, opposition is growing; France's Christian Noyer is on that side now too.

ECB Governing Council consists of 24 main decision makers in the central bank: six members of the Executive Boards, and governors of 18 national central banks in the Euro area. Now, there are:

  • Mario Draghi (ECB president),
  • Vitor Constancio (ECB VP),
  • Benoit Coeure (Executive Board member),
  • Sabine Lautenschlager (Executive Board member),
  • Yves Mersch (Executive Board member),
  • Peter Praet (Executive Board member),
  • Luc Coene (Banque Nationale de Belgique),
  • Jens Weidmann (Deutsche Bundesbank),
  • Ardo Hansson (Eesti Pank),
  • Patrick Honohan (Central Bank of Ireland),
  • Yannis Stournaras (Bank of Greece),
  • Luis Maria Linde (Banco de Espana),
  • Christian Noyer (Banque de France),
  • Ignazio Visco (Banca d'Italia),
  • Chrystalla Georghadji (Central Bank of Cyprus),
  • Ilmars Rimsevics (Latvijas Banka),
  • Gaston Reinesch (Banque centrale du Luxembourg),
  • Josef Bonnici (Central Bank of Malta),
  • Klaas Knot (De Nederlandsche Bank),
  • Ewald Nowotny (Oesterreichische Nationalbank),
  • Carlos Costa (Banco de Portugal),
  • Bostjan Jazbec (Banka Slovenije),
  • Jozef Makuch (Narodna banka Slovenska),
  • Erkki Liikanen (Suomen Pankki - Finlands Bank).

It is still unknown as to who is the insider that spoke with Reuters about igrowing dissents within ECB, but Jens Weidmann of Bundesbank has been known to vocally speak out against ECB policy in the past.

The main debate now is occupied by two opposing sides: the pro-austerity and the pro-stimulus. Do we have to restrain people so they spend less, or do we encourage them too spend more? Austerity and stimulus are not exactly lives in the same sphere; one is commonly spoken as fiscal term, while the other's in monetary approach. However, applying the two policies at the same time will negate each other's effect. What the market want to see is for ECB to launch a full-blown Quatitative Easing.

Still, not all economy that have taken that path is successful in getting out of the dump. Japan is a perfect example of how years of stimulus failed to revive the economy. And Germany seemed to be afraid if all else fail then they will be left holding on to worthless bonds.

Here is the thing. ECB was established by all central bank in the Euro area, but the main share is held by Bundesbank, German's legendary central bank. In a Quantitative Easing scenario, the central bank will have to buy sovereign bonds of all countries that fulfill a certain criteria; including those that was released by virtually poor countries on the fringe of Eurozone. If in the future the region is saved from recession, then the bonds could be released back to the market at a good price as the governments would be able to pay back what they owed.

However, if Eurozone's future is doomed, then the governments will default, and those bonds will be nothing more than junks. As the largest share of ECB belongs to the Germans, then the bulk of the weight falls to them too. Doomed if they don't, doomed if they do; really, we cannot fault Jens Weidmann, the president of Bundesbank, to publicly oppose Draghi.

At this point, the ECB has started buying corporate bonds. The New York Times reported that as of October 31st, ECB has bought 4.8 billion Euros (6 billion USD) of covered bonds, and planned to buy more in the next months. That decision has not gone unchallenged, as proven by the Reuters report. But even so, analyst don't expect it to have significant impact; to get the kind of result people desired, it is predicted that ECB will actually have to take on QE.

 

Draghi Wins

In this light, ECB decision to keep rate and policy unchanged tonight (6/11) is not surprising. The ECB has to sort out its internal struggles first before they can decide on a way out of disinflation. However, it seems that no matter what opposition says, Draghi seems to hold quite a strong influence on the board still, since ECB decision was accompanied by another pledge that the central bank is ready to add another large-scale stimulus. Here are two key points from Draghi statements:

 

1. This is the main message: The balance sheet will continue to expand.

Draghi clearly stated that if the ongoing policy is unfruitful, then ECB is ready to do more. The New York Times alluded that ECB are ready to inject the economy with as much as 1 trillion Euros and market players are already thinking that it means ECB is walking toward QE. While Bloomberg reported that the ECB Governor said they are going to keep bond-buying program for at least two years and move its balance sheet toward early-2012 levels.

European

 

2. It's fairly normal to disagree about things.

Draghi unequivocally reject the recent report about growing dissent among the 24 members of ECB governing council, underlining the fact that all of them has unanimously agreed to expand bond-buying program if necessary. Questions remain on what kind of expansion the ECB will take in the future, and whether they are going to make it into QE at all. But for now, the market is glowing on Draghi's guarantee.

 

Policy Divergence

In the last two weeks, currency market has seen some of its most wild ride. Bank of Japan surprising stimulus expansion has prompted daily spot forex jumped to three year high, according to Reuters. The event occured on October 31st in trading platform EBS, one of the main forex trading platform for banks and other big players. The BoJ, along with its counterparts, US The Fed, BoE, and ECB, together has driven market volatility this year. Although in the beginning of the year, it seemed that geopolitical risk will maintain its hold among market players, its just the icing on the cake; the real cake is central banks' monetary policies that continue to grow further apart.

Not unexpectedly, market players has been playing as they always do; root for one currency when its central bank tightens its purse, and happily sell it off when the central bank loosen their purse strings. The behavior is related to common knowledge on the supply and demand of money; but lately, it also has something to do with how some economies remain slack even after their central banks launched various measures to revive them. The situation was made even worse by internal struggles in which policy makers are having disagreement over what course of action is best to stop downward spiral.

In the circumstances, it is worth for traders to note policy makers' tendencies; whether they are doves, or hawks, or anything else. That's why US the Fed's meeting minutes are important; the minutes will tell people of who thinks what. And it will be interesting next year, when the ECB will start publishing their own meeting minutes. For now, though, let's just say, we are still selling the Euro. What about you?