Is the Euro Holding Off its Reaction to Trichets Comments?

ECB Rate Decision (OCT) (12:45 GMT, 07:45 EST)                         

Actual:                   3.25%   

Expected:            3.25%       

Previous:              3.25%                                                     

How Did the Markets React?

Generally it is interest rate decisions that put the markets in motion, but this was not the case with today’s ECB rate decision.  With North-American liquidity just coming online as the European Central Bank announced that they would keep their overnight lending rate unchanged for another month, the FX market offered little more than a quiet reaction.  It can be argued that the currency market may have already priced in Trichet’s hawkish stance, but judging from the reactions in the bond and stock markets, not all traders were expecting such strong words from the central banker.  Not only did he essentially give the market a 100 percent guarantee that rates will be raised in December, but he was also very optimistic about growth while weary about the upside risks to inflation.  With US non-farm payrolls due for release on Friday morning, if the reaction in the stock and bond markets are correct, currency traders may be holding off their own reaction to Trichet’s comments until they get the green light from the US NFP print. 

Bonds – 10 Year German Bunds

Bunds were already on the move lower when the debt markets opened for trade inEurope.  From the reaction in prices after the decision to leave rates untouched, it was obvious that traders were already expecting this from the central bank.  Although there was a bit of position squaring before the press conference, once ECB President Trichet began to speak, bond traders became more comfortable and continued to send prices lower and yields higher.  In fact, 10 year bunds traded all the way down to a session low of 101.99 before retracing.  This suggests that not every bond trader was expecting such strong comments from Trichet and as such, they felt the need to adjust their positions.

German 10-Year Bunds (Intraday)

Equities – DAX Index                                                                        

Stocks actually had a much more violent reaction to Trichet’s comments, while bond markets had a relatively orderly one.  Although the DAX gapped lower at the open, the losses were quietly recuperated going into the ECB’s interest rate decision on the back of strong PMI reports.  However once Trichet repeated his familiar belief that “strong vigilance” is needed to tackle inflation, stocks collapsed.  The prospect of higher interest rates is never good for businesses and Trichet’s unwavering concern about inflation sent the DAX tumbling from 6280 to a low of 6201.  A portion of these losses were eventually recovered, but based upon the price action, it is clear that the stock market did not like Trichet’s comments and was not necessarily expecting it.

Currencies – EUR/USD

The FX market on the other hand was the only market that barely had a reaction to the comments made at the ECB press conference.  The Euro was quietly creeping higher since the beginning of the European trading session and once the actual interest rate decision was announced, there was a 15 pip rally in the EUR/USD that was reversed just as quickly as it was incurred.  Once Trichet began to speak, his strong comments gave Euro bulls the confidence to extend gains, albeit only by another 10 pips.  For a product that can easily move 100 points a day, this muted reaction is clear evidence that either the currency market has already priced in this decision completely or is waiting to do so after the US non-farm payrolls release on Friday.  Should payrolls come out very weak, we may see Euro bulls may race out of their pens and send the pair soaring to fresh monthly highs.