Notes From Underground: The Market Looks to Germany and Japan

Yes, the U.S. unemployment data grabbed the headlines on Friday as the non farm payroll headline number was lower than consensus again. More importantly, the revision to the very weak December payrolls of 74,000 jobs was only revised upwards by 1,000. Average hourly earnings and hours worked were also weak and after the initial drop in the stock indices, equity markets spent the entire day rallying. It seems weak data powers the equity markets’ understanding of the Fed’s forward guidance. Tapering is not tightening and the Fed will keep rates low for a very long time and let the 6.5% unemployment threshold be a mere “candle in the wind.” The Canadian data was better than expected but did substantiate Thursday’s strength in the IVEY PMI. The strong global equity markets were also supported by diminished fears from the emerging markets as investors have lost the sense of urgency to flee all EMs.

***The key global macro story was out of Germany as the German Constitutional Court rendered a decision that on first read “was no decision.” Wolfgang Manchau has a piece in tomorrow’s Financial Times titled, “German Ruling Boosts the Eurosceptics.” I agree with his opening sentence: “When the first headlines came out on Friday morning, it looked as if the German Constitutional  Court had caved in …” This was my feeling as I read and reread the reports on the court’s decision but as more news came out over the weekend it appears that the German high court was far more clever in its decision.

The London Telegraph’s Ambrose Evans-Pritchard was more bold in his opinion piece, “German Court Parks Tank on ECB Lawn, Kills OMT Bond Rescue.” Pritchard writes,”The Court considers the OMT decision incompatible with primary law…” The eight justices said they were “… inclined to regard the OMT decision as an ULTRA VIRES ACT, adding that this creates an obligation of German authorities to refrain from implementing it.” (Ultra Vires is a Latin term which means “Beyond the Powers.”) The court held that Draghi’s effort to do “whatever it takes” had exceeded the powers granted to the bank under the Lisbon Treaty and the Maastricht Accord. But then the German Court passes on a comprehensive ruling and said that the European Court of Justice should render a decision on the legality of the OMT.

The Pritchard piece quotes Ebrahim Rahbari of Citigroup: “The surprise decision was a ‘clear negative’ that binds the hands of the ECB. While the European Court may eventually validate the OMT, it cannot deviate far from the German verdict without provoking a political backlash.” This is a brilliant analysis of what the GCC did for if the ECJ validates the Draghi OMT then it is negating the Lisbon Treaty of no MONETARY FINANCING that President Draghi pontificated at Thursday’s press conference. If the ECB‘s OMT plan is upheld by the ECJ then the Germans anti-euro groups can claim that the Germans were sold a fraudulent deal and call for a referendum in order to secure the support for a different EU then originally agreed. Evans-Pritchard further supports his argument by quoting Udo di Fabio, a former judge at the Verfassungsgericht and author of earlier rulings on the euro. He said, “… the Court is deliberately fencing in the ECJ, constraining its room for manoeuvre by issuing its own prior judgment.” And even the ardent supporter of the entire EU project, Manchau says, “IF THE ECJ WERE TO SIDE WITH THE ECB,WE WOULD END UP WITH A ‘CONSTITUTIONAL CRISIS’,WHEREBY GERMAN CONSTITUTIONAL LAW DIRECTLY CONTRADICTS EU LAW.” (emphasis mine)

If the theory about the German Court playing a classic gambit to force the ECJ to render a decision is true, those buyers of European peripheral bonds are going to get nervous. Let’s monitor the spreads between BUNDS and Italian, French, Spanish paper for the validity of the theory. Mario Draghi,back to center stage.And let us remember the German High Court’s views from 1993—-“…The sovereign states are the masters of the EU treaties and not the other way around.”HMMMM–Hegel versus Marx played out in real-time!

***Japan’s weekend election brought the predicted result of the pro-nuclear camp holding sway in the Tokyo gubernatorial contest. Prime Minister Abe’s candidate Yoichi Masuzoe defeated an anti-nuclear group supported by the always-popular, previous Prime Minister Koizume. The turnout was low as Tokyo experienced a heavy snowfall–34% vote versus 48% for the last gubernatorial election. But if Japanese polls are like the U.S., when a sensitive issue is on the ballot, the emotion of the groups usually brings a larger turnout so I don’t know how to judge this result. The exit polls did show that voters placed a higher priority on jobs and the economy with the nuclear reactor issue being third. It is important to see if Abe tries to turn this election result into a greater effort to get the nuclear reactors back into operation.

Tonight the Japanese government announced that its current account deficit expanded, again. The recent depreciation in the YEN has not yet resulted in increased exports but has had a significant impact on the increased cost of imported fossil fuels, playing into the hands of the pro-nuclear crowd.The high cost of energy is seen as a negative for the economy and even the labor unions are in favor of restarting the reactors to help lower costs. Just the beginning of the argument but lower energy costs would provide the BOJ with more room to move on QE.

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5 Responses to “Notes From Underground: The Market Looks to Germany and Japan”

  1. asherz Says:

    We have all seen how the Greenspan put ended in 2000 and the Bernanke put in 2008. The European peripheral bond buyers are confident that the Draghi put will allow them to continue getting superior returns. Those who disregard Santayana’s maxim, will experience an uncomfortable experience.

    We know how Marxism ended. We still don’t know whether Hegelianism will ultimately triumph.

  2. Chicken Says:

    Rinji news o moshiagemasu.
    Godzilla ga Ginza houmen e mukatte imasu.
    Daishikyuu hinan shite kudasai.
    Run for your lives!
    Sorry, but I still like that song too!

  3. Arthur Says:

    Feed the fire! The German court and the European Central Bank: Who is exceeding their powers?

  4. Dustin L. Says:

    Yra-I thought Wolfgang Manchau’s piece was right on the mark. What keeps going through my mind however though is that even if the OMT is dead in the water, is the ECB really constrained? The most troubling for loosening monetary policy in Europe was the constitutional wording in which they viewed the OMT results in loosing fiscal sovereignty by being forced to take losses in the event of depreciation of the purchased assets. There has been much talk as I am sure you are aware about using a basket of sovereign EZ bonds to purchase as an alternative to the OMT, but would the Bundesbank would probably hate this idea as much as the OMT as it would still be monetization just unselectively and lacking ESM conditionality. In other words mutualized Eurobonds in disguise without yielding fiscal sovereignty. If the ECB were simply targeting deflation, maybe the best option would be to purchase corporates and equities, but this would not as directly help sovereign debt levels and could actually hurt them if rates rose for sovereigns too much if the inflation effect of the asset purchases was greater than the liquidity effect. Which, in turn would likely hurt bank balance sheets despite seeing gains in corporate bond and equity portfolios (which are shrinking as prop trading winds down) . And once again the Bundesbank is already worried about a real estate bubble in Germany and are quite comfortable with inflation rates in Germany. So, they are likely to oppose loosening policy. So the real issue, despite all the headlines continues to be the paradox of a monetary union which lacks cohesion in terms of fiscal policy, political motives, language, and cultural cohesiveness. With inflation differentials as wide as they are and the very different economic make-up of the EZ, political fervour stirring, a hopeless generation which wants/needs change, how will the elites/bureaucrats hold this together? Timing is everything, but the future of the Euro doesn’t look good and this ruling just adds fuel to this slow burning fire. I don’t think Draghi can buy 18 months worth of time. This ruling might just see Super Mario act lowering rates come March if the data keeps coming in weak and then wonder what the heck he can do next?

  5. yra Says:

    Mario is getting to the end of the music–and he knows it.He is a superb central banker in terms of knowing how to buy time,unfortunately with no political power to put a common policy into place,time is reading quickly

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