Well, NOTES FROM UNDERGROUND gets an A+ for analysis and an F or incomplete for EXECUTION. Caught off guard by Draghi’s timing, the market never provided a rally for the more cautious trader. The euro currency began its break 55 minutes before the official ECB rate announcement as Reuters ran a story revealing the governing board’s discussion of a supposed EU500 BILLION ABS program. A leak during the meeting should provide reason for the ECB to investigate its security breaches and find out who is making money from revealing important information ahead of the governing officials. It must be like Congress, where elected representatives are allowed to be insider traders.
The official announcement revealed that the ECB was lowering the overnight lending rate by 10 basis points to 0.05 percent from 0.15 percent and pushing the ECB’s bank reserve rate to -0.20 percent. The purpose of the negative rate is to insure that banks with excess reserves from the Targeted LTRO program won’t put those reserves on deposit at the ECB but put the money to work by lending to private sectors, or to at least keep purchasing sovereign debt. But the thrust of the Draghi plan is to unlock the clogged arteries of credit by purchasing bad loans from the EU banking sector through the ABS program. Bad loans will be securitized to enable banks to lend out money received through the TLTRO program.
As President Draghi noted in his press conference, the EU banking system is responsible for almost 80 percent of credit creation in the European financial system. Mario Draghi let it be known to the Brussels Eurocrats that interest rates are now locked on the floor at the LOWER BOUND or ZERO and it is up to the politicians to enforce the GRAND BARGAIN, meaning that monetary policy is complete and fiscal and structural reforms are now needed to provide the incentives for economic growth. The press kept asking if the vote was UNANIMOUS. The answer was NO as there were dissenters. Guess who?
While we’re not certain we can surmise it was the German core group of central banks. In a rebuff to the dissenters, President Draghi noted that in order to get structural change in the European financial system nations would have to agree to SHARE SOVEREIGNTY with the central authorities, hinting for the need for fiscal harmonization to provide for a common EUROBOND (my analysis and this was directed at the French and others). But, he also noted that in creation of the ECB national central banks had already lost sovereignty, which was a direct slap at Jens Weidmann and the Bundesbank. As Bernard Connolly warned 20 years ago, one of the main purposes of the EURO currency was for Brussels to gain control over the strict monetarists with a bent for austerity that called the Bundesbank home.
Results from the ECB:
- The euro weakened dramatically as selling prevailed from the announcement through the entire session. I believe part of the selling was from the vast amount of selling by foreigners who had loaded up on European sovereign debt unhedged. In an era of ultra low interest rates, it is too costly to buy a BOND yielding 2.5% and put the appropriate hedges in place. This is one of the increased risks created by central banks and its ZIRP;
- If the Draghi plan is successful, European equities OUGHT to outperform. The uncertainty around the European economies have pressured stock indices relative to the U.S. market. Now, with the HOPE of clearing some of the stagnant credit channels the European equities should receive some inflows, especially for the large European multinationals that may gain further benefit from a weakening euro. The recent weakness in the EURO has been a story of capital flows. When European bond yields were higher than U.S. yields, the flows to Europe were in. However, the recent fall in European yields have led to an outflow of global money as it sought refuge in the U.S. and other havens. Will the ECB mimic Bernanke and provide a PORTFOLIO BALANCE CHANNEL for European investors and pension funds?
- The question for global investors will be how the ECB‘s actions affect the Bank of Japan as recent economic performance has worsened in Japan. Every major world economy is essentially locked into a ZIRP environment but each has had sub par growth. How will the Japanese authorities react to the negative rate policy of the ECB?; and
- What will the Swiss National Bank be forced to do if the euro weakens and presses on the SNB-imposed floor of 1.20 EUR/CHF. Volatility in the currency markets is on the rise as much uncertainty exists in the world of zero interest rates
***Tomorrow’s unemployment data in the U.S. and Canada will be minor relative to the ECB actions. But as always the average hourly earnings will be front and center to see if the U.S. economy is finally to beginning to reward its workers. What the Yellen Fed is watching for in order to deem its policies a success. Average hourly earnings are projected to rise 0.2 percent after a previous no increase and NONFARM PAYROLLS are expected at 230,000. The number may be stronger if state and local governments actually begin adding jobs after cutting for the previous five years. In Canada, the manufacturing jobs will be an important indicator to see if the U.S. auto sector has provided growth for Canada, especially with the recent weakness in the Canadian dollar this year.
The Canadian unemployment report is projected to show an increase of 10,000 jobs after last months revised gain of 41,000 jobs, but many of those were deemed part-time. So, if the Canadian jobs number is to be robust there will have to be a sizable increase in full-time employment. If the Canadian jobs data is strong look for the LOONIE to gain against all major currencies as the Canadian two-year note at a 1.1% yield in a negative rate global environment will be deemed a high value asset.