Will Mario Draghi destroy the euro?

Today, the US markets are closed for Labor Day, so I will follow up on my coverage of the euro, because currency markets are very much open for business.

All eyes of currency traders will be on what Mario Draghi is expected to announce early this month. Because of persistently weak eurozone economies and now, even Germany appears to be struggling the consensus is that the European Central Bank (ECB) will soon engage in their own version of QE.

This is a stimulus scheme that they have steadfastly resisted in the past, mainly on the back of the conservative Bundesbank's refusal to monetise sovereign debt.

Start your trial of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up for MoneyWeek’s free twice-daily newsletter.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Sign up

The latest data shows the inflation rate is falling and is approaching the dreaded deflation rate at zero (it's currently at 0.4%). The ECB is under huge pressure to do something and do it pronto.

Because the ECB is expected to follow in the footsteps of the US Fed and hoover up sovereign debt, bond yields of Portugal, Greece, Spain and Italy have been pushed down to ultra-low levels by traders who anticipate cashing out massive profits to the ECB. We shall see if the ECB will be so obliging.

This has been the thinking behind the heavy selling pressure on the euro in recent weeks and has become the mainstream belief. The assumption is that with money-printing comes a massive increase in euro supply and hence a decline in its exchange rate. This is all very understandable (but probably wrong!).

As Joe Granville a well-known trader of yesteryear maintained: "When everyone believes something is obvious, it is obviously wrong".

We are all familiar with seemingly perverse market moves in the face of an important development that should' have indicated the opposite move. This is often a case of a buying the rumour, selling the news' event, and I am wondering if such a thing could happen with the euro.

An opportunity or a trap?

my last post of 20 August

Short-term traders were thus presented with an opportunity to take good profits on their shorts.

But how does the hourly chart appear now?

These are my tramlines from before. They are not particularly impressive, with the lower tramline having few accurate touch points. The upper tramline is a little better, but with the market toying with the lower line, the upper one isn't in play at the moment.

Last week, the market moved lower and has been wobbling around the tramline as traders position themselves ahead of the expected ECB announcement.

And with this volatile action around my tramline, it is no longer acting as it should as a line of support, and I decide to abandon it.

This is the correct action to take. When your tramlines cease acting as solid lines of support or resistance, then you need to take a hard look whether you should continue to rely on them.

But with the positive-momentum divergence (red bars), is the market preparing for a bounce up? Selling pressure appears to be waning, and that would certainly surprise the large army of shorts, which had fresh reinforcements last week as shown by the latest commitments of traders (COT) data:

The trend-following hedgies swung even more to the bearish side and are now holding a four-to-one ratio of short to long positions. These are the very conditions where a swift reversal can occur.

Not only that, but the latest DSI (Daily Sentiment Indicator) data shows that there are only around 13% bulls a multi-month record-low reading. The last time it was this low (in July 2012), the market a major low (check your charts!).

The question I have is this: what if Draghi does announce a quantitative easing scheme, but does not involve massive sovereign bond-buying in the same way as the Fed did? We may yet see fireworks in the euro.