Notes From Underground

In a “flash,” the LONG DOLLAR positions of the taper crowd came a crashing down upon committed U.S. dollar bulls. The position unwinding started during President Mario Draghi’s press conference. I was a very attentive listener to the Q&A session and am very hard pressed to see anything positive about Europe in Draghi’s answers. In fact, the EURO began its rally just after said that the ECB was “… technically ready for negative rates.” It seems that the ECB council was again discussing the possibility of having EONIA go negative in an effort to unlock the bank deposits currently sitting at the ECB. The fact that the ECB has drawn up plans for “GOING NEGATIVE” is not a bullish EURO indicator. The most bullish and honest statement from President Draghi was he maintained that the ECB has been the most conservative of all the central banks.

President Draghi’s reiteration that 60% of the LTRO loans have been repaid to the ECB was also bullish for the EURO, but he admitted that the downside of that was that banks were not lending the cheap money to credible borrowers. Mario Draghi patted himself on the back when he said that the OMT (Outright Monetary Transaction) program announced last July has been one of the most successful measures taken in recent times. The result being: 1. Stocks have gone up; 2. Cost of capital has gone down; and 3. The TARGET2 balances held by the various European national banks are back to December 2011 levels, representing a fear of rushing to Germany for safekeeping.

As I advised yesterday, President Draghi was heavily questioned about the use of a European wide asset-backed security program in which banks constrained by NON-PERFORMING LOANS would package the loans and swap them with the ECB for EUROS, thus freeing up the lending pipeline. Draghi admitted that there was a task force working on reviving the ABS market, which has been dead for years. Overall, the ECB president evaded giving a real answer and admitted he was watching the results of the German High Court decision on whether OMT and other “bailout” programs were an abrogation of the German basic law. The ECB is going to testify at the High Court hearing but Draghi is sending ECB Executive Board member Asmussen as he has a much better knowledge of German law.

President Draghi spent a great deal of time answering questions about the need for structural reform of European labor practices in order to enhance the competitiveness of the financially stressed nations. This is a meaningless proposal as how do you restructure labor when unemployment is already so high? If you go through a severe internal devaluation with wages being squeezed, then banks will be burdened with high non-performing loans and the credit channel will become more dysfunctional. The unmentioned partner to massive fiscal and labor reform is a depreciation of the EURO to help aid increased exports, but yet the EURO had a very sizeable rally today following the ECB press conference. In a counterintuitive move, the SPANISH and ITALIAN 10-YEAR BOND YIELDS soared almost 25 basis points. If all is good in Euroland why did the peripheral debt yields not drop? Draghi danced but the debt markets were moving to a different beat.

***Today’s FT had an op-ed piece by former German Chancellor Gerhard Schroeder: “France Should Copy Germany’s Reforms to Thrive.” In the article, the political power behind the great German restructuring and labor reform, HARTZ IV, says “structural reforms are necessary because of excessive debt, as well as demographic developments and international competition. Staying ahead in competitiveness on a worldwide scale must be the priority for France and for Europe. Here again, like today in the Draghi Q&A, there is a great emphasis on structural reform as being the push for the competitiveness of the financially stressed European economies. But like Draghi, former Chancellor Schroeder forgets that the ECB kept interest rates very low to help Germany through the difficult process of restructuring its rigid labor market. Oh, also the EURO has depreciated to a price level of 0.83 versus today’s overly strong 1.32 Euro to the DOLLAR. Is there is new medicine on the shelf?

***Tomorrow is unemployment Friday. The U.S. and Canadian governments will both reveal the jobs picture for their respective economies. In the U.S., consensus has the unemployment rate remaining at 7.5% with an increase of 0.2% in average hourly earnings. More importantly, NONFARM PAYROLLS are expected to increase by 155,000. Again, the larger the NFP the better it will be for the equity markets for the economy needs to see more robust growth to support the recent jump in housing activity and certainly equity valuations. Let us hope for a number above 250,000 so we can test whether the stock market is more concerned about growth or the tapering of FED bond purchases.

Tapering does not mean tightening. The Canadian data is expected to show the unemployment rate to remain at 7.2% with a net increase of 16,000 jobs created. As always, pay close attention to the Canadian manufacturing jobs component to see if U.S. auto sales are having a positive impact on the Canadian auto sector. Today the Canadians released their IVEY PMI which came in at 63.1, well above last months positive reading of 52.2. Based on this dramatic improvement, I expect a positive surprise in Canada.

Tags: ABS, Dollar, ECB, EONIA, Euro, Gerhard Schroeder, LTRO, non-performing loans, nonfarm payrolls, OMT, Target2

This entry was posted on June 6, 2013 at 7:37 pm and is filed under Currency, ECB. 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.