Mark Twain once opined it is ain’t what you don’t know that gets you in trouble, it’s what you know for sure that just ain’t so. Yesterday the market “knew” the ECB’s Mario Draghi would once again over promise, yet still over deliver. Goldman Sach’s FX strategist Robin Brooke’s recommendation was typical of the extremely bearish sentiment:
“it remains the case that downside skew in EUR/$ is modest compared to the run-up to the Jan. 22 meeting. In short, we think risk-reward to short EUR/$ into tomorrow’s meeting remains compelling and we anticipate a 2-3 big figure drop on the day.”
Yet instead of the Euro dropping 2 or 3 big figures, we got a 4 handle face ripper of a short covering rally.
The pain was especially acute in the short end of the Euro yield curve:
Now some may say that Draghi fell short on his promises.
Market pundits like Dennis Gartman had some pretty harsh words regarding the severity of the move in European markets.
“In 40 years of trading, I have never seen anything like this.” I think this comment is a tad disingenuous. With his talk of whale oil trading over the years, we all know Dennis has been trading for way, way longer than 40 years…
Not only that, but Dennis seems prone to a little hyperbole as the moves in the European markets were violent, but far from cataclysmic.
It was not Draghi’s lack of action that caused yesterday’s moves. The market simply got way ahead of itself. The ECB is continuing to be accommodative, but the market is behaving like a petulant child. Every time we get some stimulus from the ECB, all traders do is extrapolate even more. In this day and age of limited opportunities, aggressive traders take any good idea, much, much too far.
In the aftermath of the snapback, they sit around blaming Goldman Sachs, Mario Draghi, or whoever they can point the finger at for the volatility.
What if traders are about to make the same mistake in the US?
This morning the US government released the latest employment figures. They were once again good enough to keep Yellen on track for the first rate hike at this December 16th meeting. It seems like every time I turn on the TV, or read a research piece, there is yet another call for the US dollar rally to accelerate with the Fed’s coming rate hike. Everyone is recommending buying US dollars, selling commodities and US bonds.
I am not sure about the timing, but sometime between now and December 16th, this trade will be “fully baked in.” I still contend the Fed will find the most dovish way possible to make this first hike.
This “buy the rumour sell the news” setup is so obvious, my only concern is that the US dollar will roll over even before the actual news.
To top it off, we are in the final stretch into year end. Traders with positions that have worked (like long US dollars and short commodities) will be loathe to unwind before the turn of the calendar year.
But make no mistake, the risks of these trades reversing hard are high. In the coming weeks, expect more volatility than the great sperm whale oil crash of 1891.
Thanks for reading and have a great week-end,