Notes From Underground

Catching up: As the world knows, the ECB cut the overnight rate 25 basis points to 0.25%. The cut was more symbolic than substantial for the “recent” threat of a deflationary spiral will require more action than a mere drop in rates. The front month EURIBOR contract gained just two and a half points showing the cut in rates was certainly anticipated–DECEMBER EURIBOR rose to 0.99790 from 0.99765. The more important part was the symbolic nature of Draghi defying Bundesbank chieftain Jens Weidmann. Now that the German elections are over Mario Draghi wants to let the world know that he is in charge of the ECB board and will not be intimidated by the giant shadow cast by the Bundesbank, which is also headquartered in Frankfurt.

In tomorrow’s Financial Times there’s an article by Peter Spiegel, “ECB Split Stokes German Backlash Fears,” which reveals that Draghi’s ECB Board had six dissenting votes against the timing of Thursday’s rate cut. The Dutch, Austrians and the two German members were among those opposed to the 25 basis point cut. The danger of the German opposition is that it can harden into an intransigent position against a EU single banking supervisor and single resolution mechanism, which would put an end to the ECB backstopping EU banks. The need for a EU single banking system has grown in importance as Portuguese, Spanish and Italian banks have been increasing their holdings of sovereign government bonds. A November 7 Bloomberg article by Neal Armstrong revealed that Spain’s banks “… own almost eight times more of that nation’s sovereign bonds than they did at the beginning of the debt crisis in 2008. Portugal’s largest publicly traded financial institutions boosted holdings by 6.2% in the third quarter. Italy’s banks have bought about 20 %of the securities from the euro area’s biggest debtor.”

THIS IS WHAT I AM CALLING THE DRAGHI DILEMMA. It seems that the European debt markets have stabilized because regional banks have loaded their balance sheets with their own government debt as they believe in Draghi’s “whatever it takes” mantra and thus the EU. BUT IF THE EU’S MAIN PAYMASTERS BALK AT THE ECB’S POLICIES WHO WILL BE LEFT TO CO-SIGN? The ECB is going to do an asset quality review of 124 regional banks but as this balance sheets and assets are stuffed with European sovereign debt will the ECB be an objective auditor? Again, this is the Draghi dilemma as he tries to serve many masters and A QUARTER POINT INTEREST RATE CUT IS MERELY A SYMBOLIC GESTURE. Germany’s recalcitrant stance on fiscal austerity is causing resentment from the rest of the world even as the U.S. has labelled the Germans a currency manipulator and cited it to do more to increase domestic demand.

The problem with the U.S. view from a pure stance of currency manipulation is that in 2012 “… 69 percent of german exports went to European countries and 57 percent to members of the EU.” (Caroline Baum, “Drunk on Debt, U.S. Tells Teetotaler to Sober Up”). The EU is a free-trade zone so the problem is not one of Chinese like mercantilism but something greater–a disparity of economic and financial cultures within the EU. Germany needs to alter its savings-based culture if it is to be a member of the EURO or else become a transfer agent of its huge current account surplus and financially support its debt-plagued brethren (or more weight on the Draghi dilemma). Europe will need to resolve the existential problem of the German current account, but I would suggest that the U.S. stay out of the debate for fear of isolating Germany and forcing her to turn to other allies. Remember that Russia is currently supplying almost 50 percent of Germany’s energy needs and with Merkel’s anti-nuclear program in place that dependency is sure to increase. The European financial landscape is difficult so remain leery of mere correlation of value sell-side recommendations.

****The unemployment data on Friday surprised the markets as NONFARM PAYROLLS were almost twice consensus projections (when you include upside corrections to August and September). I am not smart enough to pretend that I understand the data with all the noise created from the Washington shutdown and also the significant drop in the participation rate. But here is what I do know: THE FED IS CAUGHT IN A TERRIBLE BIND. The idea of the unemployment threshold being set at 6.5 percent is causing problems for as the participation rate drops the unemployment rate decreases faster meaning that the FED reaches its self-imposed trigger point of having to raise rates. More importantly, the issue of the dreaded “tapering” is again front and center as the employment data reflects a more robust economy. Recent FED research seems to suggest that the FED would like to TAPER as soon as possible but is fearful of a repeat of summer’s rise in interest rates on the long-end of the curve, potentially killing off loan demand for homes and autos.

***Speaking of China, the FT reported over the weekend that Bloomberg News has been self-censoring its reporters so as not to  upset the Chinese leadership and risk its bureau in China. “Bloomberg’s decision not to print the story comes as China becomes even more aggressive in clamping down on the foreign media. Bloomberg’s website has been blocked since last year when it published an expose on the wealth accumulated by relatives of China’s President XI JINPING. It is also having trouble getting journalist visas for reporters.” This is another real-time reminder of why I give very little credence to the economic data that flows out of China. It calls to question the CNBC talking heads that treat the Chinese data as market moving events. Oh well, being enamored with Jack Welch leads one to believe anything.

Tags: ECB, EU, Euribor, Euro, Fed, Fed Funds, Mario Draghi, nonfarm payrolls, PIMCO, tapering

This entry was posted on November 10, 2013 at 8:19 pm and is filed under Currency, ECB, Fed, United States. 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.