Are Mario Draghi’s days numbered?

Yesterday’s much-anticipated announcement from the European Central Bank (ECB) was the spark that fired up the EUR/USD rocket. It gained a massive three cents plus on the day. And that sharp rally immediately following the news was surely not a total surprise to my readers.

But it certainly was a surprise to most observers who had convinced themselves that Draghi had just about given them a cast-iron guarantee that the ‘stimulus’ he would unleash would be a game-changer. In the event, it was more a damp squib than a big bazooka.

Just yesterday, headlines blared that Draghi had been given the ‘green light’ to unleash massive ‘stimulus’ following the just-released negative inflation data for the eurozone. How wrong can you be?

But this could be a game-changer alright. The credibility of Draghi and his ECB is now in tatters – and should never recover. He had wound the markets up to expect that big bazooka in the form of aggressive Nirp (negative interest rate policy) and massive expansion of bond-buying, yet delivered a pale imitation.

The markets took it very badly with stocks and bond yields collapsing as the euro exploded.

Central banks can only fight reality for so long

I have long  said that the demise of the major central banks will come when stockmarkets in particular resume their bear trend in a deflationary collapse – and this is a major nail in their coffin. After all, one of the major goals of a central bank is to keep stock and bond markets elevated. That was getting increasingly difficult in the face of continued weak economic data.

Stock valuations have been pushed to the limit by faith in the central banks to keep hosing as much liquidity as the money managers require to keep them happy. Suddenly, they are very unhappy – and money managers will start to have the veil lifted from their eyes. The Wizard of Oz really is a fake.

In my post of last Friday (“Speculators are massively short the euro – and I think it’s about to turn”), I laid out my case to expect a vigorous change of trend very soon. And my firm view was verified in spades yesterday.

My forecast was partly based on the extreme sentiment picture, but also on the chart patterns forming last week. The last part of the decline off the early November high was forming a very convincing falling wedge pattern. My lower line was a superb line of support having those seven very accurate touch points.

Here is the hourly chart I showed:

EUR/USD spread betting forex chart

My line in the sand was my upper wedge line and once that line could be broken, I forecast it was off to the races northwards. I plotted the price area where the army of bears would start to get worried – and begin aggressively covering some of their shorts. Of course, that was also an area for my small band of euro bull compatriots to clamber on board the rocket.

This is the updated hourly chart:

EUR/USD spread betting chart

And that is what you get when too many passengers run to one side of the ship: it capsizes.

To illustrate, here is the latest COT (commitments of traders) data (although it is a little out of date as it was compiled on 24 November when the euro was still in decline):

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of EUR 125,000) Open interest: 557,979
Commitments
78,344 244,663 66,411 363,374 153,317 508,129 464,391 49,850 93,588
Changes from 11/17/15 (Change in open interest: 8,750)
-2,769 6,970 520 11,960 1,347 9,711 8,837 -962 -87
Percent of open in terest for each category of traders
14.0 43.8 11.9 65.1 27.5 91.1 83.2 8.9 16.8
Number of traders in each category (Total traders: 271)
62 125 73 58 65 164 219

 

On that date, money managers (non-commercials) were over three-to-one short and were adding to their short bets in style. The data for 1 December will be released later today – and I am willing to bet that even more managers have been joining their bearish colleagues.

What’s more, with the DSI reading coming in at only 3% bulls recently, the market was primed for a turn.

What next for the euro?

My first main target is the Fibonacci 50% level and the market almost made it in one day. Note that when a massive short squeeze is on, the gains of one day can erase the decline that took over a month to form! That surely must be a shock to any euro bear.

So how does this fit into the bigger picture? On the daily chart, the November plunge is wave 3 and yesterday’s spike is part of wave 4 up which should be in the form of an A-B-C. When complete, a fresh decline will be wave 5:

EUR/USD spread betting chart

But there is a valid alternative! Instead of waves 1, 2 and 3 we really have an A-B-C which is counter-trend. This count implies a much higher rally potential – perhaps up to make a kiss on the centre tramline above the 1.12 area.

In either case, a decent rally is in prospect – and will end when ironically the money managers have turned much more bullish the euro!

But looming is the US Fed meeting on the 16th which is at least of equal importance. The market is convinced that Yellen will raise US rates. But now that the dollar is being knocked off its perch, will she really go ahead with that plan? After all, a declining dollar will be seen as helping the struggling US export sector which needs all the help it can get.

Expect more fireworks this month.