Market Insider

Not so easy: Super Mario delivers shocking pain

Have the ECB's policies been effective?
Have the ECB's policies been effective?
Mario Draghi: Aiming to keep inflation close to 2%
Mario Draghi: Aiming to keep inflation close to 2%
Mario Draghi: Extends asset purchase program
Mario Draghi: Extends asset purchase program

The European Central Bank shocked markets Thursday, delivering an easing package that paled in comparison to market expectations.

The dollar index sank as the euro abruptly sprinted higher after ECB President Mario Draghi announced an increase in the type of bonds the ECB would buy, but not an anticipated increase in the 60 billion euro bond purchases. The ECB also announced a negative 0.30 deposit rate, when some analysts expected a minus 0.40 percent rate. The easing package comes as the Fed gets set to take an opposite tact and tighten policy with a first rate hike later this month.

"This is a bit of a watershed event. I think that part of the violent reaction in markets is this is the first time Draghi was rebuffed," said Robert Sinche, global analyst with Amherst Pierpont. "An internal ECB issue becomes an external markets issue. This is not insignificant. From now on when Draghi makes his comments, people will say 'maybe.' There's never been a 'maybe' around Draghi's comments since he said he'd do whatever it takes."

The news went to the heart of a very crowded trade — long dollar, short euro. Analysts had expected the dollar to reverse course ahead of the Fed's Dec. 16 meeting, in a "sell the news" trade. But the strong reaction in the euro on Thursday was also the response of those shorts that were forced to cover in a hurry. The euro was trading above 1.09 in late morning, a gain of 2.9 percent.

"It's classic, isn't it. We bought the rumor we sold the fact," said David Ader, chief Treasury strategist at CRT Capital. "Did he really disappoint?"

Ader said the market was overanticipating the ECB's actions. "Having priced in 100, they said we're going to get 120," he said.

Ader said the question now is has the market been overly aggressive pricing in the Fed's rate hike. Traders will be watching for hints on the Fed's easing plans in testimony from Fed Chair Janet Yellen, who testified Thursday morning in Congress before the Joint Economic Committee.

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Yellen, in comments Wednesday, reaffirmed the Fed is on track to hike, depending on economic data. The market is pricing in high odds of a Fed rate hike and the majority of economists on Wall Street expect the Fed to act on Dec. 16.

European stock markets slumped and bond yields shot higher across the euro zone. The 10-year bund was yielding as high as 0.59 percent from a low of 0.45 percent, and 2-year yields in Italy and Spain went from negative levels to positive. Euro zone yields have been moving lower ahead of the ECB, and against the direction of U.S. yields, which had moved higher in a kind of trans-Atlantic policy waltz.

"What else are you going to trade? One is a stronger dollar and the other is interest rate differentials. ... Everybody was on board. Who did not know that? Nobody was going the other way. Nobody was going to be short the dollar into Draghi and into the Fed," said Ader. He said the ECB has left the door open for more easing. "This was a collective wish versus something truly disappointing."

Read MoreECB extends QE to 2017

While it rocked global markets, the ECB should have no bearing on the Fed, which is expected to move forward in the opposite direction in two weeks with its first rate hike in nine years. Analysts expect the longer term trend for the dollar to be higher, and U.S. yields rose after the ECB action. The 10-year was at 2.24 percent and the policy sensitive 2-year was yielding 0.96. U.S. stocks initially sold off hard in the futures market, but recovered to gain slightly at the open, then turned lower again.

"I think that it was an incredibly underwhelming move and runs the risk that Draghi was rebuffed a little bit in his efforts. Draghi is a great communicator," said Sinche, adding that other members of the ECB may have wanted to see the impact of existing policy before adding more.

Draghi, in a press briefing, denied that his communications may have been flawed. In an uncharacteristically short response, he said he believes the package needs time to be fully appreciated.

The euro's wild ride started several minutes before the ECB's 7:45 a.m. ET announcement, when the Financial Times accidentally published an erroneous story saying there was no rate cut. The euro spiked above $1.07 from about $1.055.

The FT later printed a correction, noting it had accidentally published one of two pre-written stories on and that it was taking steps to avoid a similar event in the future. The FT also tweeted the incorrect story. But the euro's direction was set, and Draghi sent it soaring even more when he did not announce additional bond purchases.

The ECB did add regional bonds to its purchases.