ECB Rate Cut Isn't Guaranteed

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 |  Includes: FXE
by: Sean Bellamy McNulty

The upcoming ECB Interest Rate Decision on May 2nd at 04:45 PST has been rife with speculation of a rate cut. This stems from ECB's Vice President Vitor Constancio reiterating that the ECB stood ready to act and that the central bank still had room to cut rates below the current record low of 0.75%, as well as other central bank officials discussing that with inflation under control they are free to look at rates. Since this news began circulating in the press, the EURUSD (NYSEARCA:FXE) has rallied from 1.2950 to 1.3093.

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This could be interpreted as the market anticipating a rate cut or not. Technically, a rate cut should depreciate a currency due to the increased liquidity associated with a rate cut which increases the currency in circulation of the rate cutting country, but that hasn't always rung true. This has been most recently exemplified in the USD strength despite the largest QE program the U.S. has ever seen.

Another example is the decision around the August 2nd 2012 ECB meeting, which is the focus of this article. I remember it vividly, as I stayed late on the Hong Kong trading floor with a number of colleagues, to listen to the press conference live and position accordingly.

Despite comments from ECB President Mario Draghi suggesting further bond purchases leading up to the meeting, the ECB came up short announcing no new unconventional measures. During the announcement the EURUSD dropped significantly and Spanish and Italy bonds also performed poorly, with yields on Spanish 10 year debt rising above 7% and Italy's benchmark bonds trading 40 basis points higher at 6.33% post press conference.

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Over the longer term, the EURUSD actually rallied from the 1.20 range on August 2nd to the 1.30 range on September 21st.

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Given that majority of FOREX trader's time horizons aren't a month and a half, this immediate post press conference price action is important to be cognisant of.

The Takeaway from Past ECB Signaling

The past doesn't necessarily repeat itself, but it usually rhymes. Despite the whirlwind of speculation about an ECB rate cute, based on the ECB's past history of signalling, the rate cut is by no means a done deal. Draghi has speculated openly about taking action before, and has then gone on to disappoint market expectations.

Perhaps most telling is this statement from Draghi in his August 2nd post rate announcement press conference:

Frankly, the Governing Council as a whole should do the right thing. Whether this inspires hope or fear has more to do with psychoanalysis than economics. What dictates the Governing Council's deliberations is a cool-minded analysis of the facts.

Therefore, despite market expectations of a rate cut, Draghi has made it clear that his role isn't to psychoanalyze the markets. Don't take the headlines for granted, May 2nd, 2013 may rhyme with August 2nd, 2012.

Disclosure: I am long FXE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long FXE through a short position in the 10 Year German Bund. I am actively trading the FOREX market and may be either long or short the currencies discussed at the time of this article's publication. To see a complete list of my open FOREX trades in real time, visit mcnultycapitalmanagement.com/