Notes From Underground: Draghi Lit the Torch; Now Let the Games Begin

Wednesday brings the FOMC announcement on interest rates. Can the FED really ease more at this juncture? It seems that the financial world has come to believe that Draghi’s comments from last week were intended to prod the Bernanke-led FED to promote a greater monetary response to a drastically imploding debt crisis in Europe. I don’t believe that Chairman Bernanke will be pushed into further monetary action–outside of some kind of extended language–for the FED wants to keep the onus where it belongs … the POLITICAL POLICY ARENA. If Bernanke were to get aggressive at this juncture, the controllers of fiscal policy would get an election pass and the REPUBLIC WOULD BE ILL SERVED. The pundits are all opining that the FED’S non-action will result in a dramatic sell off of RISK. I think that is a wrong read as a passive statement will put pressure on Congress and the White House to actually take the lead and find some compromise to the FISCAL CLIFF SYNDROME.

Remember, it was SCHAEUBLE and DRAGHI that were the TORCH BEARERS FOR THE DO WHATEVER IT TAKES TO PRESERVE THE EURO CAUCUS. The bigger issue becomes what the ECB will do on Thursday? A good test for this will be how the equites and GOLD react to any FED inaction. If the GOLD and S&Ps initially break and then rally, it would be a signal that in fact the markets were much more concerned about a EUROPEAN RESPONSE. As of today, the 2/10 SPANISH CURVE IS HOLDING AT 165 BASIS POINTS, allowing Mario Draghi a little breathing room. If the ECB disappoints, the markets may test July 23’s low of 80 BASIS POINTS. Remember Mario, it was you who lit the torch to start the game. As usual, the markets will pick up that torch and run with it, regardless of your time lime.

The ECB is already at zero on the deposit rate so what Draghi has in store will be the key. The IOER rate at zero has been suggested of Chairman Bernanke but it seems that the FED is reticent to go to zero because of the possibility of putting added strain on MONEY MARKET FUNDS, WHICH IS A GOOD REASON FOR THE FED TO HOLD FIRE. The ECB on the other hand has already disrupted the EUROPEAN MONEY MARKET FUNDS so Draghi is left with other tools to utilize.

***In a piece on BLOOMBERG yesterday, the able economist Luigi Zingales wrote an article discussing how a BANKING UNION is the last way to save the EURO. I will not argue the merits of Zingales proposal but wish to use a quote from his writing: “The Euro’s founders designed this game of chicken on purpose,hoping that in a crisis either the periphery countries would blink and relinquish their sovereignty or Germany would cave and open its coffers.”

This is about as honest an assessment as we are going to get about the present state of the EU. It appears that Mario Draghi has been left with the task of landing a jumbo jet on the deck of an aircraft carrier. Will sovereignty be surrendered for access to the German national Treasury ? The markets are getting edgy as they want a genuine answer and time is getting short. Not only the markets want to know but the Obama team is anxious and pushing for more than a band-aid approach to policy making.

***The U.S. 2/10 curve will be a focus post-FOMC release, for a continued flattening of that curve will be problematic for the FED. The problems of Europe, the QE programs and two Operation Twists have been severe pressure on the bank’s ability to surf the curve for profit. In a world of suppressed bank earnings, the spigots of credit of barely open and this is also an issue the FED has to be concerned with. How to alleviate the problem? Bernanke will have to reach into his tool box. The FED Chairman didn’t light the torch last week but with Geithner in Frankfurt yesterday, the relay team is certainly multinational. Last week’s low in the U.S. 2/10 was roughly 119 BASIS POINTS. Let see if that area holds in the post-FOMC environment. Another solid indicator for the effectiveness of central bank policy.

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2 Responses to “Notes From Underground: Draghi Lit the Torch; Now Let the Games Begin”

  1. asherz Says:

    The markets continue to want another shot of heroin to keep the high going.. Another needle mark isn’t going to solve the problem. It will keep the the sick addict going for another few months until it wears off and the cycle starts all over. Draghi ‘s methadone won’t cure the disease..
    The problem of too much sovereign debt will not get solved with more bailouts. The U.S. has banks that are too big to fail. Peripheral Europe have sovereigns that are too big to save. Withdrawel symptoms are painful and the world will shake like never before. But thirty years of profligacy cannot be papered over.The alternative is Weimar Germany across a larger geographic area.

  2. i'm not here Says:

    The Fed pays some pitiful interest rate to the regional banks here for holding funds that the Fed required them buy at cost or basically for free. So the Fed is operating in a negative environment at the taxpayers expense, as usual…Live and learn Europe, watch the captain go down with his ship.

    Perfect time for the US Treasury to start an interest free banking system (fee based) to restore confidence in banking. Even today @ 2% or 3% mortgage loans rates, few are interested because they can’t unload their underwater mortgages. Why would Euroland be any different?

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