Market Overview

Markets Spike Higher After Reports of Mario Draghi Comments

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Markets traded higher Friday afternoon on comments from the ECB's President Mario Draghi.

Reportedly, the central bank is set to broaden its policy response to the European Debt Crisis at its policy setting meeting next week. According to Bloomberg, Draghi indicated that he would advocate further rate cuts and restarting a bond purchase program at the meeting which is set to take place August 1-2.

Risk assets across the board jumped on the comments, however, there is some room for trepidation. Draghi is only speaking for himself and potential policy has to be decided by the entire governing council of the ECB.

Notable economists who could dissent are conservative German economists such as Jens Weidmann, head of the Bundesbank. Even though he is not on the governing council, Draghi admitted late in 2011 that he does not want to alienate the Bundesbank, as did his predecessor Jean-Claude Trichet.

Draghi and Weidmann are set to have a conference call over the next few days prior to the ECB meeting. The Bundesbank has never been against rate cuts, so further cuts to the benchmark rate seem likely. A 25 basis point cut is all but priced in at this point, however a 50 basis point cut would be seen as a strong message to markets that Mr. Draghi is stepping up his game. Also, if Draghi and Weidmann can agree on the mechanics of it, bond buying seems likely to be announced next week.

Rumors on Friday hinted that the ECB would not print money in the same way as the Fed (through quantitative easing), but would rather do further LTROs to address credit conditions. Also, rumors circulated that the ECB could, on the behalf of the EFSF, purchase bonds to cap yields.

The trade to watch for such an action would be the EUR/AUD pair. This pair dropped to record lows following the rate cuts at the ECB's July meeting, and was further intensified by ensuing pressure on the euro over the finances of Spain and Italy. If the ECB is committed to restarting European growth, which has been a drag on the global economy, it would benefit Australia indirectly through China.

China's economy has slowed due to the fact that its largest trading partner, the Eurozone, is slowing. Should Europe recover, it would boost China and most likely Chinese demand for raw materials, which Australia is abundant in. This demand would boost the Aussie dollar and rate cuts and easing would weaken the euro, so shorting the EUR/AUD takes advantage of both moves.

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