Draghi Strikes Again: Talk, but No Change

The euro fell to below our $1.34 corrective target in response to ECB President Draghi's comments.  However, bids near $1.3375 appears to have stemmed to rout, at least for the moment.  It is not clear yet, if the low is in place for the day.  However, we continue to believe this decline is corrective in nature and anticipate the resumption of the uptrend.  This is the kind of pullback--more than 2% from the high, that offers opportunities for short and medium term participants.  

The key factor driving the euro higher has been the passive tightening of monetary conditions.  There is nothing Draghi said that suggest the ECB is going to take action to offset the passive tightening.  He suggested that it reflected constructive developments.  Many banks borrowed LTRO funds for precautionary reasons and no longer require it. Draghi also explained that monetary policy remains accommodative and funding is available on a full allotment basis, which is to say as much funding as the banks have collateral for, will be provided.

The fact that Draghi discussed the euro in his introductory remarks and number of times that the euro was mentioned in the press conference may suggest greater concern about the exchange rate than he let on.  Yet he seemed quite relaxed and noted the euro on a nominal and real basis was not long-term averages.  His remark about currencies reflecting fundamentals may be anticipating what the G20 says next week.  

The fact of the matter is that the different levels of competitiveness within the euro area means that thee are different pain thresholds for the exchange rate.  Among the large countries, France, Italy and Spain are less competitive and therefore the strength of the euro bites earlier than it may for Germany and the Netherlands.   

Every Friday the market's will learn how much European banks will be repaying their LTRO borrowings.  It may be coming in drips and drabs, but another large payment, perhaps in the 150-200 bln euro area, when borrowings from the second LTRO can be repaid.  

There had been some concern over the appetite for peripheral bonds.  The issue is that as bank's return funds to the ECB, it frees up collateral that was pledged for the LTRO funds.  The collateral is believed to be largely government bonds.  Now that collateral is uncovered, bank, which remain significant buyers of government bonds, may not be looking to extend exposures.  Italy's weak auction last week played on such fears but the three-tranche Spanish auction was relatively smooth.  

The government raised a little more it anticipated.  Yields were higher than prior auctions, but there has been a backing up in Spanish yields since before the funding scandal emerged. It looked like investors saw the increase in yields as an attractive concession.