Euro strengthens as Draghi buys bonds and Fed buys time

European Central Bank (ECB) President Mario Draghi has succeeded in reducing the relevance of the Bundesbanks opposition to bond purchases by making bond-purchases dependent upon ESM conditionality. And by integrating the conditionality of the ESM/EFSF plan into the much-needed bond purchase program, Draghi also firmly has sent the ball back into the courts’ of national governments.

There is no third LTRO, but there is a third bond-purchase program, with conditionality, duration and lack of ECB seniority (ECB will stand alongside other bond buyers in creditor hierarchy).

The ECB unveiled a bond-buying program in the secondary market called Outright Monetary Transactions (OMTs), which will be conditional upon the candidate countries following the austerity program under the ESM, in conjunction with the IMF and the EU (Troika). The OMT will focus on three-year government bonds, with no quantitative limits and will remain fully sterilized. There are no yield-caps in the program.

The launch of the OMT program shall depend on countries formally requesting aid from the existing rescue fund (EFSF/ESM). This implies that not only the ECB would suspend bond purchases of nations failing to meet the EFSF/ESM, but also may mean selling those bonds. EUR/USD made its fourth consecutive weekly gain — the longest winning streak since October 2010. The pair is testing a 12-month trendline resistance (1.2635), a beak of which brings back the June high of 1.2745. Support is rising to 1.2450, resting along the July trendline foundation. This likely should keep EUR/USD cemented above the 1.24, while remaining confined between its 100-DMA and 55-DMA of 1.2595 and 1.2395 respectively.

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