FX Update: Draghi Stole The Show At Jackson Hole

 | Aug 25, 2014 07:12AM ET

The EURUSD fell out of bed to open this week’s trading after Draghi’s late Friday appearance at the US Fed’s Jackson Hole conference saw the European Central Bank president discussing the prospect for more ECB stimulus and calling on EU governments to do more to boost economic growth. This has investors warming over thoughts that the ECB is eventually headed towards quantitative easing after the German 10-year Bund yield has fallen below 1.00% for the first time ever.

Draghi is fully right in arguing that if economies are to achieve lift-off, we need to see the involvement from the fiscal side, as monetary policy can’t lift the economy by printing money – as doing so doesn’t increase demand in the economy, only very weakly via wealth effects. It is going to take another recession to work through to this realisation, however, and one wonders how much economic weakness Germany would suffer before coming to this realisation and doing something about it, considering the German stance on fiscal probity.

The same goes for the US, where mid-term elections may result in a Republican majority in both houses of the US Congress – can anyone imagine a Republican effort to boost fiscal stimulus? Never... But watch for this – I am convinced that longer term we are going to see this shift in mentality. The euro and risk appetite

The rhetoric from Draghi over the weekend did help the euro lower into this week and risk appetite higher on new fevered imaginings of a fresh rung higher in QE nirvana. Increasingly, I think that risk appetite and the euro’s moves will become aligned here. In other words, the euro is the most popular funding currency now for carry trades and the market has become heavily short the currency of late. So any adjustment lower in risky assets would also likely see traders taking off their biggest trades, and help boost the euro. This trade might be more visible in the crosses like EURAUD than in EURUSD.

For now, let’s watch the German IFO to see if a weak reading can push the euro lower still. I’m beginning to get concerned that a consolidation awaits after the action has gotten very steep. The most I can imagine for now is a quick extension down to 1.3000 in EURUSD before we begin to consolidate.

Chart: EURUSD

The EURUSD action has become very steep here over the last week and the sustainability of such a move could be very limited, in time terms. In price terms, we may see EURUSD at 1.3000 first, though I suspect consolidation sets in if we see a hiccup in the animal spirits driving the latest rally in risky assets.