Is a central bank cartel at work in the markets?

On Friday, I asked “Are Draghi’s days numbered?”. That was my reaction to the utterly underwhelming damp squib that was his ‘big bazooka stimulus’ to get EZ consumer inflation rates up to their 2% target. With consumer inflation dipping into negative territory, Draghi’s target is receding even further from view.

Why does Draghi have a 2% inflation target (rather than 1% or 3%, say)? That precise figure is also adopted by the Bank of England and the US Fed – is there a central bank price-fixing cartel at work here? If so, will the authorities investigate?

I have a different theory: 2% is simply central bank mumbo-jumbo that poses a target that is so unattainable it provides cover for extending quantitative easing (QE) and Nirp (negative interest rate policy) experiments into infinity.

There is no doubt that Draghi’s stock has fallen (along with the Dax) following that disappointment. Has Draghi’s speech had the desired effect of weakening the euro even further?

It certainly has not: the EUR/USD has risen! But of course, my readers were well prepared for that outcome.

Draghi has tried to put a brave face on the market’s reaction: “Thanks to our monetary policy actions, the risk of deflation in the euro area is firmly off the table.”

But deflation remains very much on the table, with energy prices plunging. Of course, when a politician tries to reassure us, we should be firmly on our guard.

I have a target for the euro rally – and sentiment is on my side

On Friday, I showed the hourly chart below. I forecast a small dip and a final wave up to complete wave 4 before a decline to a new low in the final wave 5:

EUR/USD spread betting chart

On cue, the market dipped on Monday in a small wave b and is currently rallying in wave c. Here is the chart updated:

EUR/USD spread betting chart

My ideal target is the tramline where the market would plant a kiss in the 1.11-1.12 area. This region also spans the Fibonacci 50% and 62% resistance levels. It is a major area of resistance.

What are the odds for reaching this target? I certainly have the sentiment picture on my side. Here is the latest COT (commitments of traders) table as of 1 December, just prior to the sharp Draghi reversal:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of EUR 125,000) Open interest: 582,253
Commitments
79,343 251,373 75,625 375,821 158,556 530,788 485,554 51,465 96,699
Changes from 11/24/15 (Change in open interest: 24,274)
999 6,711 9,214 12,446 5,239 22,660 21,163 1,615 3,111
Percent of open in terest for each category of traders
13.6 43.2 13.0 64.5 27.2 91.2 83.4 8.8 16.6
Number of traders in each category (Total traders: 275)
65 124 79 58 67 168 227

 

The trend-following hedge funds pushed their luck by adding to their pile of short bets (as did the small speculators). But the smart money commercials gladly took the other side of that bet and now are positioned 2.4-to-one long.

As I have noted many times before, when a market turns, the trend-followers are caught flat-footed and the rush to cover their bets produces the very fast move we saw last week off the 3 December low.

With the rally now firmly in progress, that should stimulate more bears to cover – and propel the market even higher. The other consideration is that there are few weak euro bulls left after such a wipe-out, which means that selling by stale longs should be minimal.

As for timing, there is the crucial US Fed meeting next Wednesday which could throw many spanners in the works. Markets are firmly expecting a rise in the Fed Funds target rate, but it will likely be the language that accompanies it that the market will pay close attention to.

If the Fed infers that it is ready for more QE (to align with Draghi), the dollar should rally – and my wave 5 down in the EUR/USD chart will be in play.

I will be alert to taking profits on my long EUR/USD trades and position short. This is getting interesting!