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How Mario Draghi bluffed the markets, and the markets believed him

Financial markets are full of great poker players, but they’re usually Americans like hedge fund manager David Einhorn.

No longer. A remarkable Reuters story published earlier this week lays out how Mario Draghi, president of the European Central Bank, basically bluffed the global financial markets into doing exactly what he wanted back in July.

Here is the comment that sent hedge fund managers scrambling to cover their bets that the eurozone would fall apart: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

This is about as tough as central-banker speak gets. This is Mario Draghi as Dirty Harry. And the implication was that European leaders were on the verge of announcing a major development that would drastically change the direction of the markets. That would mean that hedge fund and other investors who were betting on the collapse of the euro zone would lose a lot of money.

The markets backed down quick. Draghi’s comments turned around market sentiment on a range of eurozone bets, from Italian and Spanish bonds, where yields had been shooting higher, to the price of the euro, which had been tumbling amid concerns about the future of the monetary bloc.

But as Reuters points out, Draghi was doing it all on a wing and a prayer. At that point, there was no major plan in place:

The truth was, the speech was just the beginning. Draghi was in no position to guarantee “whatever it takes.” His words were a gamble that set off weeks of frenzied backroom diplomacy and public sparring that would severely test the relationships of the main protagonists in the euro zone crisis.

Through conversations with senior ECB officials and leading political actors in the euro drama, most of them on condition of anonymity, Reuters has pieced together a detailed picture of the negotiations that led from Draghi’s late-July speech to his September 6 announcement that the ECB stood ready to buy “unlimited” amounts of bonds issued by the most stricken euro members.

Besides manhandling the markets, Draghi’s gamble also gave him leverage with other European leaders and helped him prod them into action. After all, having nearly promised to do something big, officials risked a sharp market collapse if they disappointed the markets.

Of course, Draghi’s bluff hasn’t solved the underlying crisis in Europe. Recently, we’ve seen concerns about Spain start to bubble up again. And it’s also possible that his credibility could take a hit. The markets might not fall for the same sleight of hand again.

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