Draghi Fans Euro Short Covering

Encouraged by the better than expected sovereign auctions today (Spain and Italy), softer than expected US data (weekly jobless claims and retail sales) and a comments from ECB's Draghi, the euro has recovered yesterday's losses and is testing resistance in near $1.2820 (that extends toward $1.2850). A failure to convincingly break this area while reinforce the consolidative nature of the price action rather than an upside correction that we expect.

There were some economists who had expected an ECB rate cut today, but on balance most, like ourselves did not. We argued that the cuts in the past two months were simply reversing the April and July rate hikes, but that with the deposit rate already at 25 bp, the next cut has greater implications. We also noted that the full extent of the ECB's past measures, like collateral liberalization, have not been fully implemented.

We had thought a February rate cut was more likely. However, comments by Draghi suggest that the odds may not be as high as we thought. He said that inflation outlook is balanced (we had thought it was to the downside, especially given the base effect). While recognizing downside economic risks, he suggested that there were tentative signs that GDP was stabilizing. It is difficult to know what he is looking at outside of some stabilization of the PMI readings in December. Even there though some of the forward looking metrics still seemed to be deteriorating, in our view.

Draghi did seem to support our assessment that, contrary to much cynicism in the media and among analysts, the LTRO was an important measure without which there were more serious and systemic funding risks. Draghi suggested that the next 3-year offering, next month, may be even better taken up because the new collateral rules will be in effect.

There does seem to be some debate over whether the ECB's actions are tantamount to quantitative easing. Draghi of course shied away from such a label and for good reason. The precise meaning is not always clear. Many insist that the Fed was engaged in QE in late 2010 through H1 2011, but the Fed itself did not call it that. The ECB's balance sheet has expanded rapidly, especially over the past several months Perhaps it is not so important how one labels the policy, but it is clear the ECB has moved dramatically since Draghi took the reins.