Notes From Underground

Thursday brings the announcements from two of the major rate setters in Europe: the Bank of England and the European Central Bank. First the BOE will announce at 6:00 a.m. CST and consensus says the bank will keep rates steady at 0.50% and the QE program at 375 billion pounds. Though the U.K. economy is soft, Governor Mervyn King will maintain a steady path so to keep his options available in case the global economy begins a new downturn. The present BOE head is retiring July 1 so it would be prudent to let his successor have as many tools to work with in a new regime.

At 6:45, the ECB will announce and though some analysts are expecting a 25 basis point cut from the present 0.75%. I believe ECB President Draghi will not cut rates until what fiscal battle plays out in the U.S. The European credit markets have been well-behaved as the yield curves have remained in a tight range and the two-year notes in the peripheries have stayed relatively low. Mario Draghi has relished being out of the limelight as the lunacy of Washington has garnered most of the financial markets’ attention. Even if the ECB were to cut the overnight rate to 0.50% it would mean very little as the MARCH EURIBOR FUTURES CONTRACT is trading at 0.9981, pricing in an effective rate of 19 basis points. It would make little sense to lower rates with so much calm in the Euro credit markets, especially since the Basel Committee has just given the European banks a massive reprieve by watering down the capital standards.

President Draghi holds his usual press conference at 7:30a.m. CST and the two issues we need to listen for are whether Draghi joins the Woodford crowd and discusses the possibility of the ECB moving to a NOMINAL GDP THRESHOLD, which is becoming the policy de jour in academic circles. Secondly, will some person ask Draghi whether or not he is concerned about the recent depreciation in the YEN? My readers are well aware that the EUR/YEN cross at some point will begin to affect German exports and act as a drag on the locomotive of Europe’s economy. Let’s listen to whether President Draghi speaks to either of these economic issues. If Nominal GDP targeting is entertained by the ECB, it will lead to a sell off of the EURO. Any concern about the recent rally if the EURO would put one more leg into the theme of a global currency war, which would be a positive for the precious metals. These will be the only two factors to cause major movement.

***The drought in the U.S. heartland continues but at present it is having no impact on grain prices. The most recent moves in the grain markets have been down as China has stepped back as an aggressive buyer of U.S. foodstuffs. Months ago I suggested that the South Americans would be planting “from fence post to fence post” as grain prices skyrocketed. The Brazilian and Argentinian corn and bean crops have had idyllic weather so it seems that Asian buyers are waiting to see just how large the harvest is going to be. Once you throw in the weakness of the Brazilian real, the Chinese will be getting a much better price than if they had continued buying only U.S. production. As long as the weather in South America stays, prices will remain somewhat soft. If the weather pattern changes to hot and dry the Chinese will become aggressive buyers. Friday brings an important USDA global and U.S. grain report. I advise caution as the January report has a tendency to create volatility. Also, if the Brazilian real were to begin to appreciate, it would also cause the Chinese to begin to purchase grain.

***The U.S. government has this week extended itself into what should be considered IMPERIAL OVERREACH. The Canadian National Post reported that the U.S. Coast Guard was given the legislative authority to conduct a risk assessment of the increased ship traffic resulting from increased pipelines to Vancouver. The EPA wants to measure if there is spill response capacity. Also the Coast Guard is being directed “to analyze the toxicity of diluted bitumen”–a heavier oil that is produced from the tar sands. The U.S. is putting pressure on the Canadians with “soft power” just after the Keystone pipeline was blocked and Kinder Morgan announced it was proposing a $4 billion pipeline expansion of its TransMountain project that brings oil from Alberta to Vancouver.

Today a Financial Times story by Jim Pickard reported that the U.S. has warned the U.K. and PM David Cameron about leaving the European Union. The U.S. made it very clear that the U.K. OUGHT to stay in the EU. Phillip Gordon, U.S. Assistant Secretary for European Affairs, is quoted as saying: “We have a growing relationship with the EU as an institution, which has an increasing voice in the world, and we want to see a strong British voice in the EU. That is in America’s interests. We welcome an outward-looking EU with Britain in it.” These two incidents are going to give the world cause for concern as U.S. policy seems to involve itself in the domestic political issues of allies. Maybe the Chinese will do a pivot to the West.

Tags: BOE, Brazil, China, ECB, Eur/Yen, euribor futures, Euro, nominal GDP, QE, Real, USDA crop report

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