When ‘Super Mario’ Becomes ‘Gun-Shy Draghi’

Draghi Bazooka

Mario Draghi, the president of the European Central Bank did what he had to do; he expanded the ECB’s stimulus program and has cut the deposit rate even further, from -0.2% to -0.3%  which makes it more expensive for banks to ‘park’ their cash at the central bank. That in itself already is a pretty aggressive move as not a lot of central banks (at least not the central banks of developed and first-tier nations) have dared to reduce the interest rates to less than zero in the past.

ECB Twitter

Source: ECB Twitter Account

The market reacted negatively and not only did the European indices fall by 3-3.5% from the intra-day high, the Euro gained a lot of strength versus the US Dollar and that wasn’t really the effect Draghi and his ECB-friends had been hoping for. In just a few minutes, the Euro gained 2.5-3% versus the majority of the other currencies. The stronger Euro will make it harder for the Eurozone to strengthen its position on the export market.

This also partly confirmed our thesis in our previous column, where we explained the US Dollar might have strengthened too fast and there might be a ‘cooling down’ period in the works. Let’s now have a look at the chart of the past week:

USD

Source:stockcharts.com

In just one week since we warned the US Dollar might be overheating, the currency lost approximately 2.5% of its value with the majority of that loss occurring in one day. And just to give you an idea of how important and impressive this sudden swing was, on Thursday we saw the sixth largest EUR/USD swing in 25 years time!

This indicated the market was expecting the ECB to take much more aggressive measures, but the European Central Bank failed to deliver on these expectations. Draghi tried to backpedal a bit on Friday by stating that an increase in the monthly amount that’s being pumped in the financial markets could still increase, but that seemed to be too little, too late.

The ECB’s decision could also have an impact on the rate hike decision of the Federal Reserve as chances are the US Dollar would indeed strengthen even further and a Dollar that’s suddenly strengthening by 5% in a matter of days/weeks might not be ideal for the country’s export position. However, we would expect a rate hike to already be fully priced in by now and the increase in the gold price last Friday might confirm this indication. The jobs report was actually better than expected as not only was the total amount of newly created jobs higher than expected, there were also some positive revisions of the job creation number in the previous few months.

The rate hike is very likely fully priced in, and the market is already anticipating another rate hike before next summer as the futures of the 30 day Federal Funds Rate  is indicating the market is now expecting a more aggressive rate hike than before.

30 Fed Funds

Source: CME Group

As you can see, the future contract for June next year is trading at less than 99.5 indicating there’s a very high chance there will be another rate hike by July. But it gets even ‘worse’ than that. Looking at all contracts for next year, the future for December 2016 is trading at 99.14 which basically means the market is already pricing in a 0.75% rate hike in the next 12 months, and that would be a more aggressive hike than we originally anticipated and imagined.

It now sure looks like the market has braced itself for the worst with a surprisingly pessimistic expectation of the upcoming rate hikes. And as we saw on the European markets, any different outcome than what the market was expecting might have a huge impact on the markets.

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First published here: http://www.zerohedge.com/news/2015-12-06/when-super-mario-becomes-gun-shy-draghi

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