The Biggest Takeaway from the European Central Bank Rate Cut? Short the Euro

short the euro Traders looking to short the euro got another cue from the European Central Bank (ECB) Thursday morning, with bank president Mario Draghi announcing a number of new inflationary monetary policy measures to take hold in October.

Prompted by an entrenched malaise in the Eurozone economy, and a fear of disinflation, Draghi announced a rate cut in the ECB's liquidity program to 0.05% from 0.15%, and a cut to overnight credit to 0.3% from 0.4%. There was also a cut to the already negative ECB deposit rate, from -0.1% to -0.2%.

Additionally, the central bank will begin purchasing nonfinancial asset-backed securities to the tune of $500 billion euros over the next three years.

Thursday evening on CNBC World, Money Morning's Chief Investment Strategist Keith Fitz-Gerald said that by cutting rates and purchasing asset-backed securities, Draghi and the ECB are doing the only thing logically available to them as they try to address the Eurozone's stagnant economy. That will all work to devalue the euro.

"If you look at central bankers around the world, they've got one key theme in common and that is create the illusion of prosperity, because as long as they can do that, they can inflate markets," Fitz-Gerald said. "So yes, the euro is going to drop."

 



On the announcement, the euro sank below $1.31 to lows it hasn't seen since July 2013, falling 0.7% to $1.3037 once Draghi's remarks sunk in on the foreign exchange markets. European markets saw a boost from the development, with the Euro Stoxx 50 initially up about 24 points on the news.

While unexpected, the announcement is not yet the large-scale quantitative easing program that many see as an inevitable policy measure for the ECB. Draghi did, however, indicate in his speech Thursday morning that should the economic conditions in the Eurozone warrant it, the ECB is ready to make use of "additional unconventional instruments within its mandate."

What this means is Draghi is moving ever closer to an expansive sovereign bond-buying program.
And when that happens, you're going to want to be on the short side of the euro...

Why Go Short on the Euro

Eurozone QE is slowly becoming the worst-kept secret coming out of the ECB.

"This is pretty much set in stone; it's a question of 'when' at this point and no longer 'if,'" said Money Morning Resource Specialist Peter Krauth.

There is a lot of pressure on Draghi to reverse this troubling trend of disinflation and to stave off the specter of deflation, as the current Eurozone inflation rate is near a five-year low of 0.3% for August.

If deflation takes hold, prices will drop, corporate profits could potentially dry up, and wages will shrink - all of which could reinforce the region's elevated unemployment rate that is now flagging at 11.5%.

Deflation also makes borrowing more difficult, increasing the real value of debt and putting borrowers at a disadvantage. This would prompt banks to tighten lending standards, and the last thing banks in the Eurozone periphery countries like Portugal, Ireland, Greece, and Spain need is a credit crunch just as their financial system was beginning to open up to outside markets.

If the Eurozone wants to avoid ending up like Japan, which has battled with deflation for almost two decades and still has yet to see its premier market index, the Nikkei Stock Average, recover even half of its losses since its 1989 peak, the ECB is going to need to add fuel to the inflationary fire.

And it's also in the best interest of the ECB to see the euro devalued, as that will help bring the current accounts of the periphery into balance by encouraging foreign capital through stronger exporting.

But don't be so eager to short just yet...

When to Short the Euro

short the euro chartThursday's announcement out of the ECB only reinforces the monetary policy path that the region is setting out for - which will cause the euro to fall.

But as the euro continues to trade below its 50-day and 200-day moving averages, and is trading down almost eight weeks in a row, there's a chance it could get a short-term boost.

"I wouldn't be jumping to short the euro right now," said Krauth. "I do believe we might actually get a little bit of sideways action and a little bit of a climb at this point just because we've had a clear and extended drop."

These drops could shake out a few of the bears and lead to a quick ascent in the euro's value. And when Draghi does make it clear that he will pursue easing, that one instance of certainty in an otherwise highly uncertain economy could give added strength to the currency.

The euro could make a quick rally back to its support levels of around $1.33 and $1.34, before easing does set in and the value is diminished. That will be the time to get in on the short selling.

You can also place your bets against the currency by getting in on the ProShares UltraShort Euro ETF (NYSE Arca: EUO), an exchange-traded fund that aims to generate twice the inverse daily returns of the dollar price of the euro.

More from Peter Krauth: Numerous factors are building that make today's silver prices look downright cheap. Here's how you can invest in silver today for double-digit gains...