Mario Draghi, the ECB President, announced yesterday that the ECB stands ready to do whatever is necessary to ensure the Euro will not become an extinct currency. Thanks to his remarks yesterday global equity markets staged a rally and the Euro posted a sharp rally against its major trading partners. Bond markets in Italy and Spain soared as bond traders expect ECB intervention.
Traders were desperate for good news and it only took a little spark to ignite the powder keg everyone was tossing around. There are a few major problems in the Eurozone:
1. There is no banking union. The ECB does not have the right to step in member countries and make decisions the way other central banks are allowed to.
2. There are very big differences in the North and South of Europe and therefore very difficult to make please all member countries.
3. There is no one regulator for all member countries. Fiscal problems in each country are handled by that country. The bailout of PIIGS was the first move as a united momentary union and pointed out the flaws in the system.
The ECB has lowered interest rates by 25 basis points to 0.75% and slashed the overnight deposit rate to 0 at its latest meeting earlier this month. Draghi’s comments hinted ECB interference through bond purchases and took it one step further and suggested a Euro Bond. A dangerous promise as there is major opposition in the ECB, especially from German members of the board.
Hopes are high now and the pressure is on Draghi to deliver. Financial moves inspired by hope are ready for a quick reversal back to the previous trend. Draghi talked the talk, but he may not be able to walk the walk as he will not have the necessary tools to deliver on his speech.
We are one headline away to plunge global financial markets into free fall.
The rally was nice and will be short-lived. Traders should not be surprised to see global financial markets plunge next week in excess of three percent as everyone will have the time to digest the news of the past 24 hours and realize that nothing has changed. The problems are the same and Draghi hinted at something traders would like to see, but he can’t deliver to them.
Global financial markets were oversold and traders took the news to look in profits by covering their shorts. This morning new short positions are being initiated and next week we will continue the downward trend as there is no real solution to the many problems, at least no yet. The first real step may not come until 2013 and global financial markets are ready for a rather sharp correction.
The good news is that the Euro debt crisis will eventually force politicians to create the monetary and financial union necessary. Unlike the U.S. in 2008 the EU will get a fresh start. A new chance to re-create the old world and make it new again as a complete overhaul will be enforced. The new system will be thrown out and we will starts from zero.
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