If there is to be a key turning point in Europe’s long running economic crises, ECB President Mario Draghi has now set the scene. After weeks of rumour and innuendo, overnight Draghi unveiled his grand rescue plan in what appears to be the most ambitious plan yet to get Europe’s periphery back on the straight and narrow. While keeping the official refinance rate on hold at 0.75 percent, Draghi outlined his plan to aid peripheral debt markets by making “outright monetary transactions,” (OMT’s) in the secondary debt market. These OMT’s will not have a predetermined size, suggesting the ECB could make potentially unlimited purchases in an effort to reduce peripheral borrowing costs, with a focus on bonds maturities of 1-3 years, including longer-dated debt with 3-years left to mature. The purchases will not take the form of a U.S style quantitative easing program, with capital injected into peripheral bond markets to be sterilized, which requires the bank to take the equivalent amount of funds out of the financial system in an effort to avoid stoking inflation. Under the plan, the ECB will waive their seniority status; with both private investors and the European Central Bank of equal status should a default occur. Nevertheless, strict conditionality will be attached to be eligible for the program, which now puts the onus on countries such as Spain to make an official request for a bailout. For now all of Draghi’s chips are on the table in what appears the most decisive of plans yet, but it’s clear the baton has now been handed to Spanish PM Mariano Rajoy to balance the benefits of the program at the expense of the nation’s sovereignty, which will require Spain to adhere to terms set-out by the troika by accepting a bailout.
In true ‘risk-on’ fashion, risk currencies responded in kind, with the Euro regaining ground after a short dip as markets began to digest the finer points of Draghi’s speech. Nevertheless, it was the residual support which had the greatest effect with U.S markets rallying at the expense of the greenback and other safe haven units. The Aussie dollar was a prime beneficiary of this residual support which gained against both safe-havens and risk currencies alike. The local unit began its offensive after yesterday’s bittersweet employment print which saw the official jobless rate record a surprise drop from 5.2 to 5.1 percent in August. Traders were transfixed on the drop of the headline rate despite the rather uninspiring finer points which showed net losses of 8,800 jobs. An excess of short-players leading into the release prompted a squeeze and the upside which was maintained as markets responded to Draghi’s rescue plan. The commodity bloc lead the charge higher against the greenback overnight coinciding with solid gains across U.S equities with the DOW and S&P both finishing above 2 percent on the day. U.S markets were also encouraged by a solid ADP employment print and weekly jobless claims data which is seen as a positive precursor ahead of Friday’s non-farm payrolls – however, should we see a similar out-performance from the official report, it may materially bring down the odds of the Fed launching a third round of quantitative easing when the bank meets next week. This implies the risk-on rally seen overnight could fade quickly should markets begin to recalibrate the chances of QE3, in turn inspiring a greenback rally at the expense of risk counterparts.