Euro depreciation continues after Draghi speech

As I wrote only two days ago, I was waiting for the EURUSD exchange rate to hit $1.0765 and $1.06 before closing my short positions. I would not have thought that both of these take profit limits would be hit within a mere two days. So as a follow-up to Monday's post let's take another look at the monthly EURUSD chart.

EURUSD Monthly Chart 11/03/2015

EURUSD is currently trading at $1.0583, which means that all of my short positions have now been closed. Considering that the exchange rate is at a point where two trend lines -- originating from the year 2008 and 2000 respectively -- cross each other, I'm going to wait and see where it will go from here before opening new positions. As of now, I'm biased towards going long given that the euro appears oversold on a short-term horizon. A move towards $1.2 would not be unusual after such sharp declines, although both economic fundamentals and central bank policies clearly speak against such a level right now. Perhaps it is more likely that we will see $1.1 in April or May before falling back towards parity by the end of 2015.

Today's extended drop in the relative value of the euro was ignited by Mario Draghi reiterating at the 16th "The ECB and its Watchers" conference in Frankfurt the ECB's commitment to reach its long-term inflation goal and to bring the central bank's balance sheet back to $3 trillion through 2016. The key statement:

Our decision in September to make use of asset purchases had significant effects. But still, when we announced the purchase of asset-backed securities (ABSs) and covered bonds, there were some in the market place who doubted our commitment and the effectiveness of our monetary policy. They thought we might be hampered either by there being a limited availability of assets that we could purchase in the market or by legal or political obstacles to our ability to expand the range of assets, should it become necessary. If we were so constrained, that would affect our credibility because our ability to anchor expectations relies in part on the fact that we are free to set the appropriate monetary stance.

In this context, the decisions we took in January to expand the range of our asset purchases must have assuaged those concerns. We can deploy – and we are deploying – monetary policy in a way that can – and will – stabilise inflation in line with our objective.

The yields of European countries' government bonds have fallen further since the ECB started its asset purchase programme on Monday. For instance, Italy's 10-year bond yield is now at a record low 1.17% after having fallen below 1.25% yesterday. The yield of German 10yr government bonds is just 0.205% as of this writing (German government bonds with shorter maturities have offered negative yields since the beginning of the year and have since fallen even further into negative territory).

Italian 10yr generic bond yield 11/03/2015

As long as market participants believe that the ECB will be able to achieve its monetary policy goals, there is no apparent reason why the euro should appreciate significantly in 2015 and 2016. My medium-term EUR bias remains firmly short.

Only the Federal Reserve would have the fire power to steer the EURUSD exchange rate in an upward direction, but that is not going to happen unless the United States begin to see the strong US dollar as a valid threat to the nation's economic recovery. That has not been the case so far, despite a few comments from US officials about the euro being artificially undervalued as a means to support European exports. One can only hope that the Federal Reserve will not deviate from its plan to raise interest rates in 2015, because anything else would likely mean an engagement in a full-blown global currency war with unknown consequences.