Draghi Signals ECB to Join Forces With Governments to Buy Bonds
Comment of the Day

August 02 2012

Commentary by David Fuller

Draghi Signals ECB to Join Forces With Governments to Buy Bonds

This short announcement, reported here by Bloomberg, triggered a triggered a temporary 'risk-on' rally in stock markets and a sell-off in the USD:
Aug. 2 (Bloomberg) -- European Central Bank President Mario Draghi signaled the bank will join forces with governments to buy sovereign bonds in sufficient quantities to remove all doubts about the future of the euro.

Any ECB bond purchases will be conducted in a way to soothe investors' concerns about seniority, Draghi told reporters at a press conference in Frankfurt today. Details of the bond purchase plan will be fleshed out in coming weeks, he said.

Bond yields that throw into question the future of the euro are "unacceptable" and "need to be addressed in a fundamental manner," Draghi said at a press conference in Frankfurt after keeping the benchmark interest rate on hold at 0.75 percent. There is a "severe malfunctioning" in bond markets, he said.

Financial markets and politicians had ratcheted up pressure on the ECB to act after Draghi pledged last week to do "whatever it takes" to save a euro battered for almost three years by spiraling bond yields in countries from Spain to Greece. Germany's Bundesbank reiterated last week that it opposes further purchases of sovereign debt by the ECB, as they blur the line between fiscal and monetary policy.

"Governments must stand ready to activate the EFSF in bond markets," Draghi said. The central bank "may undertake outright open-market operations."

A few minutes later this expanded comment, including the Bundesbank's resistance, roiled markets into 'risk-off' mode: Draghi Says ECB Working On Bond Plan Amid Bundesbank Concern (note: the headline and article were slightly altered later on). Here is a brief sample:

The euro declined and Spanish bond yields rose after Draghi's remarks, which came after a week in which markets soared on optimism he would announce a bond-purchase plan to end the debt crisis. While Draghi's proposals go further than the ECB's market interventions to date, he signaled that the 23- member Governing Council has yet to reach a final agreement.

Bundesbank 'Reservations'

"It is clear and it is known that Mr Weidmann and the Bundesbank have their reservations about programs that buy bonds," Draghi said, referring to the head of the German central bank.

David Fuller's view We have a power struggle here, and certainly not for the first time. Led by Mr Draghi, the ECB is stretching its mandate, to put it mildly, so that it can act as a lender of last resort, just like the US Federal Reserve. The Bundesbank, which opposed the creation of the euro but lobbied successfully to have the ECB's headquarters in Frankfurt, right across the street from the German central bank, is trying to restrain Mr Draghi.

My guess is that Mr Draghi will lose some battles but win the war with the Bundesbank. After all, the ECB is officially in charge and politically astute Mr Draghi should be able to marshal more support within the 17 euro member states more often than not.

Meanwhile, is the predatory, front-running hand of high-frequency algorithmic trading (HFT) exacerbating the size and speed of market swings? You decide. Here is a small sampling of today's intraday charts: US Dollar Index, EUR/USD, 30-Yr T-Bond futures, gold, silver, IBEX and DAX.

Surprise announcements and sudden price swings have always been a part of market activity. But until the last few years, had we ever seen so many and such sharp intraday price swings?

Not in the 46 years that I have been closely monitoring global markets. There was plenty of volatility but in earlier decades, sharp intraday moves that might have taken up to an hour now occur in a few minutes. I attribute this mainly to HFT.

Some of the HFT firms make billions. If you agree that markets are a zero sum game, the unlevel playing field created by HFT means that plenty of other traders and investors are losing.

Back to top