Notes From Underground: There Will Be No Independen​ce From the ECB or BOE

Ah, July 4 and the living is easy but the trading is difficult. The algo trading models make data releases perilous but the influence of geopolitical events results in more variables in motion, thus the yellow flag is waved and caution is advised. Brazil, Turkey and certainly Egypt are in crisis mode. The military has seemingly taken control of the Egyptian government and as I write it is uncertain as to what the response will be from the supporters of President Morsi. The markets will at first blush will support the imposition of military rule for Notes From Underground‘s first law is MONEY IS FASCIST, meaning it craves POLITICAL STABILITY as a prerequisite.Wealth would trade away democratic rights and the privileges of freedom in order to be secure. My definition of fascism is the state-invoked power to provide stability (Mussolini making the trains run on time). Guaranteed payment of principal and interest supercedes all. What comes further down the road from suppression of liberties will be dealt with later: GIVE ME STABILITY OR THE RETURN OF MY ASSETS. As one of my friends and readers summed it up last week (to the tune of Randy Newman’s “Political Science”):

If Turkey is troubled, Syria in flames,
China slowing and Brazil the same,
So let’s liquidate now
Ben hates us anyhow…

***Tomorrow, while the U.S. is celebrating the day of the issuance of the Declaration of Independence, the Europeans will have two key central bank meetings with the results released at the usual times. First, the Bank of England will announce its interest rate decision at 6:00 a.m. CST and it will be the first meeting under new governor, Mark Carney. Consensus is for no change from its current rate of  0.50%.

The recent data out of the U.K. has been tepid but no new weakening. Since this will be Carney’s first meeting, he will not prevail in any efforts to increase the present BOND BUYING PROGRAM. Recall that the previous governor, Mervyn King, was rebuffed three times by his Monetary Policy Committee in an effort to increase the present QE program. Governor Carney will not risk losing a vote at his inaugural meeting.

Forty-five minutes later, the ECB‘s President Draghi will release the decision of the bank. There will be no change to the current rate structure of 0.50% and a bank reserve rate of zero. At 7:30 a.m., President Draghi will hold his regular press conference and it is here will there can be some market-oriented fireworks. The ECB president will be on what he will do calm this week’s turmoil in the credit markets of the European peripheries.

The Portuguese 10-year note rose to 7.5% today after the resignation of Portugal’s finance and foreign ministers. The market is worried that the Portuguese government may fall under the pressure of continued austerity programs forced upon the Lisbon government in order to qualify for sovereign and bank bailouts. The EU, ECB and IMF have lauded the Prime Minister Coelho for his fortitude in imposing austerity in an effort to please Brussels. If austerity is called to question by the peripheries, the untested quantitative easing program (OMT) that Mario Draghi has called an unmitigated success will be called upon to help curb the volatility in credit markets. Today, the Portuguese TWO-YEAR NOTE rose 128 BASIS POINTS and the 2/10 curve flattened by 55 BASIS POINTS.

It was the inability of peripheral governments last July to fund themselves in the short-term debt markets that prompted Mario Draghi to make his speech “about doing whatever it takes.” The Greeks are also back on the boil as the 10-YEAR Greek note has increased in yield to 11.5%, while rates are also rising in Italy and Spain. Mr. Draghi will be asked about what the ECB will do to stem the FRAGMENTATION IN BORROWING COSTS ACROSS THE EU. The OMT is based on CONDITIONALITIES of SEVERE AUSTERITY for anyone taking OMT funds.

With the FED talking tapering and rates moving up all over the world, the ECB‘s honeymoon is over. If President Draghi again invokes the idea of the ECB imposing NEGATIVE RATES on overnight reserves the EURO will be under severe pressure so the crosses will be the place to trade. Do your work and watch the euro cross rates for opportunities.

***Quick Hitter: Monday night when the Aussie RBA announced an unchanged decision on the overnight lending rate, there was a line in the press release that I found of interest. “It is possible that the exchange rate will depreciate further over time,WHICH WOULD HELP TO FOSTER A REBALANCING OF GROWTH IN THE ECONOMY” (emphasis mine). The RBA is very aware of what economists call the DUTCH DISEASE, which dates back to Holland in the 1970s when a natural gas find off the Dutch coast led to a large appreciation in the Dutch guilder and hurt many of the domestic manufacturers as Dutch products became non-competitive based on the “benefits” of a natural resource find.

The Australians seem to think that China’s growth has fueled a natural resource boom in Australia and the inflow of foreign investments drove the Aussie dollar to a level where the rest of the Aussie economy has suffered a competitive disadvantage. My Question to Governor Stevens: What took you so long? I have argued for the last year that the 2/10 yield curve in Australia was signaling that the RBA needed to loosen monetary policy. The curve has moved out 80 BASIS POINTS during the last two months, closing today at 122.7. The RBA is evidently comfortable for now, but another cut in rates is certainly in reason … OK, after the September election.

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