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Why Can't Central Banks Contain Investor Enthusiasm?

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Why Can't Central Banks Contain Investor Enthusiasm? PART 1 OF 5

Did Markets Get Draghi’s Message Wrong?

The first step toward exit

ECB (European Central Bank) President Mario Draghi in his speech on the June 27 said that the ECB may have to change its policy to keep the central bank’s accommodative stance unchanged. This was an attempt by Draghi to cool market expectations of a tightening policy from the ECB, as the previous statement from him after the ECB meeting on June 7 signaled a cautious exit from the current quantitative easing program.

The ECB’s statement highlighted the favorable balance of risks and markets as a reason that the central bank would be slowly inching toward an exit from its quantitative easing program.

Did Markets Get Draghi’s Message Wrong?

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Market reaction

European markets (VGK) (EZU) were quick to pick up on the hints. European Bond Markets (IGOV) witnessed some selling off after these comments, as tightening from the ECB would lead to higher yields and lower bond prices.

The euro (FXE), on the other hand, rallied to a fresh one-year high of ~1.144 on June 29. The prospect of monetary tightening or a rate hike from the ECB, improving economic conditions, and a stable political scenario in the Eurozone is leading to increased bets on further appreciation of the euro against the US dollar (UUP) among other major EU trading partners.

Did markets misread Draghi’s message?

Is this enthusiasm justified? The sharp rise in the euro and the fall in bonds reflect a belief among investors that the ECB will tighten its monetary policy in the months ahead. But the ECB has tried to talk down this enthusiasm by saying that Draghi’s comments have been misjudged.

In this series, we’ll analyze comments from key members of the ECB as well as the surprise turn of events at the Bank of England.

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