Notes From Underground

The last two days has seen two of the world’s key central banks deliver fresh interest rate decisions and there was very little in way of surprises. In a salute to the philosopher Isiah Berlin, I have noted that Chairman Bernanke is a HEDGEHOG and President Draghi a FOX. A hedgehog is one who “views the world through a single defining idea.” The economy is slowing, unemployment is high, inflation is low, so it is appropriate for the FED to buy and continue buying Treasury debt. You say it is not having the desired effect? Buy more. In yesterday’s FOMC statement, the FED noted that  “… FISCAL POLICY IS RESTRAINING ECONOMIC GROWTH.” The meaning of this is that Washington is acting irresponsibly, thus the FED needs to possibly INCREASE its bond and mortgage-backed securities purchases. Whatever it is, QE IS THE ANSWER.

I believe that Chairman Bernanke is a fine fellow, but he is an academic married to the output of his beloved financial models. If the economy fails to respond to the continued efforts to pump in the liquidity, it must be because of countervailing forces beyond the FED’S control: Fukushima, Superstorm Sandy and, of course, the governing mess in Washington. The models are correct and will be proven so over time.

Today, the European Central Bank  provided the consensus outlook with the predicted 25 basis point CUT in the lending rate. As the ECB statement was absorbed, the EURO actually rallied and made overnight highs during the time before the 7:30 press conference. Then it was time for the EURO FOX to answer questions from the press. President Draghi was busy telling the press how successful the ECB had been in restoring calm to the credit and sovereign debt markets since July 2012. While FRAGMENTATION continues to plague the private lending markets, the sovereign debt markets have responded well to Outright Monetary Transactions (OMT) and yields on sovereign debt have collapsed as Italy has just experienced all-time lows on its two-year notes. The ECB cannot easily solve the FRAGMENTATION PROBLEM because it is the bank market that provides credit to small businesses and large corporations while the capital markets are a very junior player.

In the U.S., it is the capital markets that provide the bulk of credit, therefore the FED has a greater ability to impact credit through involving itself in the capital markets. Mario Draghi also admonished the fiscal authorities in Europe for the emphasis on austerity and especially the push to raise taxes in a recession. If governments want to cut spending, then it should also be cutting taxes in an effort to stimulate investment. Draghi also promoted the idea of increasing the importance of the European corporate debt markets through increased development of the asset-backed securities market. An ABS market would go a long way to free up collateral and put it to use in the REPO. It would also free up the ECB from being the sole repository of all types of collateral and would put some velocity into the moribund debt markets. Then Draghi unleashed his INTERNAL FOX–“a person who draws on a wide variety of experiences and the world cannot be boiled down to a single idea.”

When asked why the ECB cut at this time and not previously, the FOX maintained that at this meeting the consensus was stronger. Then came the coup de grace from a man who understands markets, and this led to the sharp fall in the EURO: THE ECB DEPOSIT RATES CAN GO NEGATIVE REGARDLESS OF THE CONSEQUENCES. This issue was dropped into the discussion as a trial balloon to see the market impact of NEGATIVE DEPOSIT RATES. The FED and others have discussed the concept, but there are fears about the impact of negative rates on the money market funds. Not for the FOX. We can do less and the consequences will be worked through. Remember that while Mr. Draghi has promoted the importance of the OMT program it has never been called for and it cannot because the conditions to utilize this tool require drinking from the “cup of severe budget austerity.”

OMT conditionality was a demand of the Bundesbank and Chancellor Merkel to placate the hard money crowd. Thus, the concept of NEGATIVE DEPOSIT RATES was meant to move markets and test German resolve. The FOX is sensing the backlash to austerity and feels he can push back against the European core. The recent slowing in Germany’s economy and the Dutch nervousness over continuing budget austerity seems to have emboldened President Draghi–a huge political gamble based on his “wide variety of experiences.” He better hope that Weidmann and the German leadership are not hedgehogs of austerity. “Gort, Klaatu Barada Nikto” (From the movie, The Day the Earth Stood Still).

***Today, Canadian Finance Minister Flaherty named Stephen Poloz the new governor of the BOC to replace Mark Carney. It seems that the market was surprised by the selection as Poloz is considered an outsider to the BOC and may be too political a selection. The LOONIE (Canadian Dollar) was sold on the news as the current second-in-command Tiff Macklem was widely expected to succeed Carney. The uncertainty bothered the markets but the more I read about Poloz the more he seems to be a pick that has theoretical as well as practical experience. Most importantly, he has worked for the BOC and spent five years at the highly regarded Bank Credit Analyst under the auspices of Tony Boekh and Donald Storey. Real world experience … imagine.

***Tomorrow is UNEMPLOYMENT FRIDAY in the U.S. (Canada won’t be released until next week). The consensus on non farm payroll is for 155,000 jobs, the overall rate to remain at 7.6% and average hourly earnings to increase 0.2%. This number is diminished in importance because of the ECB and FED this week, but AHE is important because there has to be proof of wage gains to support consumer demand. It does seem that some FED watchers are now keenly watching the participation rate (how many people are in the workforce). Skeptics have viewed the 7.6% rate as meaningless because so many potential workers have dropped out of the wage pool.

The labor force participation rate presently is a multi-decade low of 63.3%. The lack of traction in the job market and the very low LFPR is making some FOMC members leery of the 6.5% unemployment rate so is cited as a FED threshold, allowing for some to push for a lower rate of 5.5%. It will take some outstanding job growth numbers to force the FED to reduce its bond purchasing programs. In my mind, the most bullish number for the equity markets and the U.S. dollar would be a NFP of more than 220,000. The economy needs to see some sustained improvement in the private sector jobs situation.

Tags: Ben Bernanke, BOC, ECB, Fed, FOMC, Mario Draghi, Mark Carney, QE, Stephen Poloz, U.S. unemployment report

This entry was posted on May 2, 2013 at 8:30 pm and is filed under BOC, ECB, Europe, Fed, unemployment. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.