Our man in Frankfurt did not disappoint today. He was at his best as he kept the “unconventional tool” of negative interest rates in his bag of tricks. Again, the ECB President did not need to expand one euro to achieve a positive outcome. The euro rallied for a brief minute as the report came that the ECB announced “NO CHANGE” in policy. However, as traders we noticed that it was the smallest rally as market expectations were wrong. The EURO remained offered all day once the press conference began and Mr. Draghi announced that the meeting was unanimous in its approach to the use of unconventional tools to combat the UNDER UTILIZED CAPACITY IN THE LABOR FORCE AND THE THREAT OF DEFLATION. The ECB went through his usual litany of reasons as to why the European economies remained with an output gap and subdued inflation: lower energy and food prices, plus the fact that the coming asset quality review was keeping banks from lending. The ECB is aware that bank lending is much more important to the European economy than in the U.S. as the American corporate bond market plays a much greater role in finance.
The problem for European banks is that they have absorbed so much sovereign debt that it limits the ability to make loans. The ECB seems intent on swapping those sovereign bonds for cash through the creation of an asset-backed security market but for now the market is not large enough to have the impact the ECB desires. Yesterday, the French central bank raised the possibility of it setting up some type of ABS program for French domestic banks in an effort to increase their lending capabilities. The French want the banks to release their non-performing loans into a type of swap with the French central bank. Give us your poor, tired loans, yearning to breathe free and we will give you cash. This will be the prototype for any ECB quantitative easing program. The kicker here is that President Draghi said the “ECB CAN ACT SWIFTLY IS NEED BE.” My interpretation is the ECB has provided its leader with the ability to act without an ECB meeting. Remember, when Mario made his famous statement about no TABOOS AND WHATEVER IT TAKES, it was in the middle of a funding crisis and in between ECB meetings. Mario Draghi pre-announced the Outright Monetary Transactions (OMT) before any meeting. Mario Draghi’s efforts has been an unmitigated success and through his magic the ECB has greenlit him to act. As Paul Newman says, “Sometimes Nothin’ Can Be A Cool Hand.”
***Governor Jeremy Stein, my recent favorite Fed governor for his measured and thoughtful research on the Fed’s causing the mispricing of credit risk, submitted his resignation from the FED BOARD OF GOVERNORS (effective May 28). The professor is heading back to Harvard to spend more time with his students. NOT! It seems that Professor Stein is the odd man out and has lost the intellectual battle over Fed policy and the need for the Fed to evaluate financial risk in setting policy. As one of my key sources so aptly said: “The Last Adult Has Left The Room.” The resignation comes after a recent speech by Stein that evidently left him as a hater in a room of lovers. Jeremy Stein is a Fed Governor and not a district president so any dissension from him carries more weight than Richard Fisher. This is not an insignificant event and look for Jeremy Stein to raise his voice in criticizing the current Fed. He will do it through the research he alluded to in his recent speech about Financial Market Vulnerability (FMV). After the unemployment data is released tomorrow, I will watch to see if the Stein resignation has any impact on the market.