The euro project is a unique experiment in human history. It is the only time that mankind created a currency without a country.
The eurozone remains a hodgepodge of wildly different cultures, from the tax-evading Greeks to the very stiff and proper Germans. Everyone is ruled by their own individual governments, and yet they share a common monetary policy and the same currency.
That makes Mario Draghi, who is the president of the European Central Bank (ECB), not only the most powerful monetary authority in the region, but also the most powerful official in all of Europe. If for no other reason, because the ECB is the only pan-European institution in the region with broad administrative powers.
The ECB, unlike the Fed, has only one mandate: Price stability. That has made it much more difficult for European authorities to engage in the type of monetary stimulus that the Fed has been doing for the past eight years.
Yet Mr. Draghi has managed to implement a QE (quantitative easing) program of his own, under the supposition that European central bankers have the obligation to fight deflation as well as inflation. Therefore, the ECB is well within its right to assume massive purchases of sovereign bonds in order to lift price levels to the 2% target.
|The European Central bank has been buying bonds like crazy to pump up the European Union’s economy. But can it keep it up?|
The ECB has been late to the QE game, but nevertheless has taken to it with great abandon. To date, it has bought bonds at a rate of 60-80 billion euros per month. And many analysts expect that when all is said and done, the ECB will have expanded its balance sheet by at least 1 trillion euros.
The key question for you and the market is when will it stop?
The EUR/USD made a massive recovery on Monday, rising almost to 1.0800 after hitting multi-month lows just above the 1.0500 level. For many novices in the market, the move came as a shock and no doubt seemed bewildering given the problems that Europe continues to face.
But currency markets rarely move in a straight line and Monday’s action was just a short squeeze after weeks and weeks of relentless selling. In fact, don’t be surprised if the EUR/USD pushes higher, maybe even all the way towards the psychologically key 1.1000 level after the ECB meeting this Thursday.
The market will be looking for Mr. Draghi to signal some sort of an extension to the QE program and perhaps even an expansion of it. But if he offers nothing of the sort, the currency could fly higher and hit 1.1000 by the end of the week. The reason? The market is still not convinced that the much anticipated “policy divergence” between the Fed and the ECB will take place.
For all the pop in the U.S. yields since Mr. Trump’s election, Fed officials have still not signaled that they are ready to truly normalize monetary policy in 2017 by forging a steady path of rate hikes every three months or so. In fact, there is a small but not inconsequential chance that the Fed will do a “one-and-done” in December and sit on their hands for much of next year much like they did this year.
That’s why Mr. Draghi’s press conference on Thursday will be watched so closely. If he offers no reason to ease further, don’t be surprised if the euro pops higher. Either way, we’ll be watching carefully for any trade opportunities to come. The euro collapse could still be coming, but not just yet.