Darshan's Blog

Darshan's Daily Market Ponderings

Trichet plays the game from 36,000ft in the air!

Wednesday February 8th, 2010

Morning all. What a blinder yesterday was! We got in at the right levels, we got out at the right levels and we reversed at the right levels. I hope you all made some money on it. What was the cause of all the volatility yesterday?

Two word 'Greece Bailout?'. With 40,000 short contracts betting on the Euro diving things got a bit frisky with the tit for tat game that Trichet dealt Greece and Goldmans. It was beautiful to watch the back and forth between the ECB and the market; the smoke and mirrors used uncited sources, market participants, uncited ECB officials. Every trick in the book was handed out. I kept you updated throughout the day in the comments section I'm a bit of a geek, so the whole day just had me excited. Remember, this whole thing happened while Trichet was still on a plane! Here is how the game played out:

ECB: Trichet cuts short a meeting in Sydney and gets on a plane to fly to an unscheduled ECB meeting.

MARKET: The market responds by ramping up in the hopes that this is the much awaited meeting that will end in a bailout for Greece being announced.

ECB:The ECB's Nowotney reminds people about the ECB's no bailout clause. The ECB go ahead with their fine-tuning operation of draining 270bn Euros of excess liquidity from the Euro-zone banking system.

MARKET: An unconfirmed rumour is released suggesting that the bailout announcement is due. This causes the market to spike and especially the Euro (however both are contained by strong resistance and the Euro failed to break 1.3850 against the USD). Is this released by the market to force the ECB's hand or is it released by the ECB to see what they can do about killing the shorts, just with rumours? I think it could be either but we will give this play to the market players on second thoughts.

ECB: Dos Santos of Portugal, denies knowing anything about this rumour. Germany follows suit.

MARKET: The market responds by dropping the Dow by 100 points and the SPX by 10 handles in 30 seconds. Sign given to the ECB to not mess with the financial markets.

ECB: German official from the ECB denies the rumour again in other words saying 'Show us what you got?

MARKET: The market holds thereby saying 'We can do this but you know what we're just going to try force your hand into a bailout it's our way of turning rumours into reality.

ECB: Germany say overnight that they are seeking a firewall around Greece's debt, to avoid it spilling over to other European countries.

MARKET: This kept the market on jitters overnight should the big guys swipe the floor out of 10,000 on the Dow or should they hold fire and wait until today to make their move? The market awaits overnight for the ECB's next move.

ECB: In steps Germany just now with a 'government official' saying that bilateral aid for Greece is not planned to their knowledge. They have no doubts about Greece's solvency and see no need to finance it before their May deadline. This is one day after, the German Finance Ministry spokesman, Michael Offer stated that the ECB official would be working on steps to prop up Greece's finances.

MARKET: The market sells off from overnight highs to test whether this is a credible promise or not.

ECB: ECB's move is next what will they do?

They have a statement out at 5.30pm (GMT) today, so I have no doubt that the market will force something out of them by selling off prior to it.

Essentially the whole market is currently riding on the hope that a bailout will be announced any moment now. Are they at risk of being disappointed by the actual solution? Perhaps. Either way, their will be a solution.

Remember, Greece's budget deficit is now four times over the 3% limit set up by the EU. Technically it should be thrown out of the circle. However, in reality that will never happen. I can actually see this being passed on to the IMF instead, rather than the EU offering credit-guarantees. It could do that in theory but then it sets in motion requests from Portugal, Italy and Spain. So how will the resolution come?

The market will have to force it's hand and make it look like the ECB had no choice. What does this mean?

Well it may mean selling off hard. Pull up a AUD/JPY chart and just look at the candles on the one minute chart. Comical how risk just did not know what to do last night. In essence the decision to reverse short in the 10100s was taken yesterday, because the AUD/JPY was approaching resistance at 79.10. It held overnight and we're a 100 pips down.

The reality is that this is nothing but a huge game of who blinks first. Does anyone including (including the banks) want this to spread to the rest of Europe? Things are still too fragile. Despite what rubbish the media tell you about things being fine again (how quick they have changed their tune btw) nobody senior is willing to risk another breakdown of the system. Goldman would love to make a short term profit by jacking up the price of insuring the debt but in the long run, they want things to be okay. It's merely about what they can get out of this mess right now, before the inevitable decision to help is made by senior central bankers.

You might ask, would it not just be simpler to remove Greece from the Euro-zone by citing their breaking of the rules? Well the whole pact is based on a non-credible threat. In reality many of the countries have been running budget deficits well above the 3% limit for years but have simply found ways of covering it up. So already the players know they can cheat and get away with it. First rule of the game don't give the players an incentive to cheat. The policy is just not enforceable. Greece et al know that. They know that if they are removed from the mechanism, then Portugal, Italy, Spain, Ireland, most of the Eastern European bloc and so on, will also have to go. That leaves Germany and France in the main. A single currency for mainly two countries? As if.

Let's see what today brings. No doubt more grandstanding, jawboning and fun volatility. It could go either way here. One thing is for sure there will be a resolution, it just depends how we get to it. At least Trichet will actually be back in Europe today.

Keep your position sizes small today and trade safe.

Darshan

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