Risk currencies rally as Draghi’s grand rescue plan hits the spot

As anticipated the focus was squarely on the European Central Bank overnight and a quick glance across currency activity shows markets haven’t walked away disappointed. It’s apparent ECB President Mario Draghi has made good on his recent pledge to do “whatever it takes” to preserve the Euro, launching an ambitious bond-buying plan in the face of persistent opposition from the influential German Bundesbank. 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.

After an initial dip, the Euro regained its footing with the EURUSD pair making a clean break to the upside of $US1.26-figure. Residual support for high-beta currencies saw the Aussie dollar outpace the Euro with a rally against Yen leading the charge higher.  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 outperformance 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 its risk counterparts. At the time of writing the Australian dollar is buying 102.8 US cents.

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