Today's EUR volatility is a prime example of how the markets initial reaction of disappointment quickly turned into a strong belief that Draghi and company will get to act in the next interest rate announcement meeting on June 5th 2014.
The single currency was within 5-pips of testing the strongly supported resistance level of €1.4000 before aggressively heading south to take out stop losses conveniently located below its first real support target of €1.3900.
Are investors being led down a similar path they took in March when Draghi vocally tried to undermine the EUR's strength? This time seems different as Draghi dropped very strong hints at possible policy action in June.
Focusing on three sets of possibilities while expressing the Bank’s serious "concerns about the strength of the currency" has the market anticipating a refi rate cut at that meeting. It’s clear that Draghi has abandoned previous ECB president's belief that the ECB never "pre-commits" - he noted if needed, that the committee had laid the foundation for action in June. The next meet will also includes fresh staff projections and Draghi and company seem comfortable in acting at that time if necessary.
Why stop at the refi rate? To prove their commitment and increase the impact, the ECB could also cut the depo rate in June. Today, conveniently Draghi was able to sidestep any questions on the possibility of a depo rate cut. Using this tool pushes the ECB into unknown 'negative' territory and a new scenario that they would not want to commit to that easily.
Nevertheless, the ECB spent most of today's meeting debating what actions to potentially take at the June meeting. Many are suggesting that such intense pre-work would insinuate that the ECB might be preparing for a combination of measures (rate cuts + targeted measures of "reducing fragmentation and improving credit flows). Euro policy makers do not seem that concerned with the recent tightness in money markets- why? This is probably due to the fact that they are looking at the very short end (week to week).
Risks to growth and inflation outlook are unchanged – inflation concerns are "limited and balanced" and the risks to growth seen on the "downside." With inflation risks somewhat benign QE really should not be on the table in the short term. The fact that Draghi stressed that the Council is unanimous in being dissatisfied with the prolonged period of low-inflation would suggest its "what are they to do" rather than not "on whether to take any at all."
Today's press conference is a rare win for Draghi and his attempts to weaken the EUR. Next month's meeting will be a cliffhanger and the ECB must deliver.
The contrarian believes the ECB will have to get by with little else, but on words alone. They will argue that with the refi rate at +0.25% cutting it will leave them "toothless and weaponless" and lead to a stampede higher from the EUR bull. Negative deposit rate also has its critics – it would seriously reduce the profitability of European banks and with Euro inflation a non-factor QE will hardly be tabled. If all true this leaves policy makers again sitting on their hands.
If nothing else, expect it to be a nervous and volatile meet for the market.