Notes From Underground: People Get Ready For The ECB Money Train

In a paean to Curtis Mayfield and the Chambers Brothers:
“People get ready,there’s a train comin’ “
It is not a LOVE train, nor PEACE train, but the market hopes a money train from Mario Draghi, the conductor of European Central Bank monetary policy. The train is scheduled to depart from Frankfurt, Germany at 6:45 a.m. and the world’s currency, commodity and equity markets are hopeful that EUROS will be providing the fuel for this locomotive.

The ECB press releases are usually boring as little information is provided and anything of importance is left to President Draghi to expound on at his press conference 45 minutes later. Tomorrow OUGHT to be different because Draghi put his thoughts out in a speech on November 21, in which he mentioned that the ECB could expand its balance sheet by a TRILLION EUROS. Draghi’s November speech resulted in the euro dropping over 1 percent and making its lowest close of the year on that day.

Yesterday and today the euro finally made a lower close as the market anticipates that the ECB will offer up a genuine QE program rather than just mere jawboning from Draghi. QE can take various forms:

  1. The ECB can buy sovereign debt but this runs into concerns from the German Constitutional Court that the ECB is in possible violation of EU treaties;
  2. The ECB can mimic the Bank of Japan (BOJ) and move to buy REITs and ETFs, which are not public debt but issues of private sector investment vehicles;
  3. The ECB can buy a multitude of various assets from corporate bonds to Draghi’s beloved asset-backed securities (ABS) and even GOLD bullion in an effort to flood the banking system with liquidity. Draghi loves the idea of ABS as it is private in nature and possibly the lowest grade of paper as the European banks relieve themselves of non-performing loans–unclogging the credit channels. Remember that Europe is much more dependent on its banks for credit than the U.S.
  4. If President Draghi wishes to upset Treasury Secretary Lew and insure a lower EURO, the ECB can announce a massive buying program of U.S. Treasuries, which would be buying public debt but not in violation of EU treaties.

These are all possible strategies to will provide for a genuine QE program. They will also circumvent BUNDESBANK concerns about the ECB undermining the European financial system by bailing out sovereign nation-states and merely monetizing domestic debt. The recent rally in the DAX–since November 21–and the strong performance of peripheral sovereign debt (particularly Italy and Spain) signals that market expectations for a firm commitment for quantitative easing is very high. IF DRAGHI DISAPPOINTS THE RESULT WILL BE A FALL IN EQUITY MARKETS AND A RALLY IN THE EURO CURRENCY. GOLD WILL ALSO FALL BUT BE READY WITH SUPPORT LEVELS AS THE MARKET WILL PERCEIVE THAT FINANCIAL RISK WILL BE ELEVATED DUE TO EUROPEAN INTRANSIGENCE. If the ECB policy remains unchanged the BUND will rally against all European debt. Doing nothing will not be a COOL HAND.

***The Bank Of Canada and the Reserve Bank of Australia both kept their interest rate and overall monetary policy unchanged–as expected. The Canadians noted the strength of the U.S. economy as providing some hope but the BOC remains concerned about the negative impact from falling energy prices. The Australians are trying to keep the Aussie dollar down to hope minimize the impact from falling global commodity prices. Seems as if everyone is waiting for President Draghi to deliver.

***The Financial Times has a very strong article on the impact of QE by one of the two credit analysts that I hold in high esteem. Manmohan Singh, Senior Economist at the IMF wrote a piece, “How QE Can Jam the Financial Plumbing,” and discusses that central banks clog the financial plumbing by purchasing high-grade collateral  and removing it from the financial system. My other favorite credit plumber, James Aitken, has long taught me about the need for high quality collateral in the repo market. When the FED and others extract HQLA from the markets via QE, less worthy borrowers are forced to pledge lower grade paper and thus pay a higher price for borrowing or may not be able to borrow at all.

In anticipation of the ECB embarking on this type of QE program Mr.Singh notes: “The ECB faces other challenges, however. Some of the best eurozone collateral is at the Swiss National Bank, as its balance sheet expanded significantly after the Swiss franc was pegged to the Euro in September 2011. This has reduced good collateral circulation in the eurozone, providing lessons for the ECB as it considers a possible QE. More generally, the ECB, as does the Fed, has to consider financial plumbing.” The burden on Draghi to craft the correct policy is great. Ok, how many syllables, Mario?

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15 Responses to “Notes From Underground: People Get Ready For The ECB Money Train”

  1. GreenAB Says:

    I expect Draghi to do nothing. Over the last few weeks the Bundesbank made it very clear that it doesn´t support outright QE and the leaked (but denied) dispute inside the ECB council looks to me like a warning sign. imo Draghi has gone VERY far already. he can´t annoy the ECBs biggest backer (Germany) forever. people over here in Germany (huge conservative savers) are already mad. talking about negative interest on large savings accounts. and: with European sovereign yields at record lows across the board he has no real argument to sell. you probably will never see a central bank official confess that their real goal isn´t lower rates anymore, but to boost asset (stock) prices. there will be the same old jawboning but no real action. just my two cents…

  2. yra Says:

    Green AB–always good to hear from you—the view from Germany is a great addition to this blog cite

  3. asherz Says:

    “If the ECB policy remains unchanged the BUND will rally against all European debt. Doing nothing will not be a COOL HAND.”

    Looks like Cool Hand Luke, also known as Jens Weidmann is calling the shots. As he is the only adult in the room understanding that the Eurozone’s problems are not solved by monetary measures (see Japan as exhibit number one) but ossified structural ones, this Draghi disappointment may be the right one in the long run, though painful short term.

  4. GreenAB Says:

    i wonder how long Draghi can keep the charade going? when will the market wake up to the fact, that his hands are tied at this point? in the Q&A his major selling point to get Germany on board for possible QE was the price stability mandate and that inflation might be getting too low. that´s very vague. and for that to occur in my opinion the EURO has to rise first significantly. since it has been doing the opposite lately some import price inflation will slowly work through the eurozone. at the same time the European economy isn´t enjoying the full benefits of lower oil prices because it´s an energy importer. it´s a bit frustrating at the pump when when you see how big oil´s been coming down and gas prices barely drip lower…

  5. yra Says:

    Green AB—the euro rally against the yen is going to cause problems for the locomotive of Europe and it is interesting that Draghi was not pressed on that issue

  6. Chicken Says:

    Europe must be turning the corner, will hold off on stimulus measures till next year! Roll out the barrels…..

  7. Blacklisted Says:

    While the world’s currency, commodity and equity markets are disappointed that EUROS were not provided as fuel for this (runaway) locomotive, investors can rest assured that bureaucrats will eventually do what’s best for them at the expense of the masses, and add more weapons grade plutonium to the nuclear bomb on this “Death Train” –

    Yes, we all have to invest for the well being of our families, but what good will it do when govt’s bail-in, seize, and tax it away? If one doesn’t think that is where we are headed and can escape the civil unrest it will produce, then they are simply naïve at best.

    “There is no more neutrality in the world. You either have to be part of the solution, or you’re going to be part of the problem.”

    T. Siedner, London

  8. yra Says:

    Black–or as they said with the healthcare act–“if you are not at the table you are on the menu”

    • Blacklisted Says:

      …which assumes there is a restaurant, or something else that’s not more nourishing. This viewpoint is similar to Chuck Prince saying, “as long as the music is playing, you’ve got to get up and dance”. Sorry, but when Donna Summer starts singing “Last Dance”, instead of dancing one could get more chairs or at least take the chains off the exit doors.

      Don’t misunderstand, your free advise is appreciated and good, otherwise I wouldn’t read it. It may be unfair to you, but this peon likes it when people with more influence stands up for what’s right and not only for their self-interest – which may be why Santelli often hits a chord inside people.

      The same thing is true in the medical profession and why it’s such a big contributor to our economic problems, which some unselfish doctors are trying to correct –

      Since we live in a political economy, I hope you don’t mind injecting politics into the discussion. I’ll keep it to a minimum.

  9. GreenAB Says:

    these are interesting times. according to German newspaper “Welt” Draghi doesn´t have the backing majority of the executive board. still policy decisions are being done by the governing council.

    i think Draghi is playing with fire here. should he really decide to move against the fiscal sound European countries, backward looking this could well become the initial step that leads to a breakup of the Eurozone.

    Merkel is trying to hold the whole thing together and break up voices have become silent over the last months. should the ECB decide to buy bonds and take the pressure of excessive EZ countries to reform and bring their budgets in order, then the whole project could be in question.

    still it would be financial suicide if the EZ would break up. but anti Euro parties will use the war over the ECB as a powerful argument.

    am i too pessimistic here? what do you guys think?

    • Blacklisted Says:

      Since the euro project has been doomed from the start by not consolidating the debts, there are only painful choices. I would not call it suicide though, since bureaucrats would never have the courage or honor and the people will never be given the choice.

      The break up of the EZ has nothing to do with anti-euro parties, and everything to do with simple exponential math – math the CB’s understand, which is why they will continue to favor equities over govt debt. The euro is already dead. The only thing left is the crying.

    • SacredReich Says:

      I don’t think that you are pessimistic in that. I too consider these times as very interesting and, looking forward, am eagerly awaiting (and, ja, anticipating…) what the next…say… two years have in store for us europeans. Looking at the macro side, it is utterly shattering how severely undynamic the euro econs have become. (An ifo survey on the lack of confidence in French govt econ policy-making is at record high. No wonder/Kein Wunder:
      I read Buba Weidmanns last three speeches last week and see him tenaciously pointing to missed opportunities for growth — reforms that were on the policy-making table 10 years ago and were watered down. Structural weaknesses are currently all abound. Even in Germany, mainstream media (NZZ, FAZ) are catching up, recognizing looming domestic weakness (I don’t mean this biz cycle/recession bla bla). Inward FDI is currently very weak, according to Buba data.
      It is beyond me how far behind the curve the whole national and EMU “leaders” are. And so, the void they are leaving is to be filled by unreasonable policy. JC Trichet spoke in his last days as ECB pres. of urgent needs for a quantum leap in EMU politics. As it stands, the ECB will leap.
      Anglophile Lichtenberg once wrote: “Aus einer Menge von unordentlichen Strichen bildet man sich leicht eine Gegend …” We will bitterly see how the european econ landscape looks when market participants again realize it’s disorderly.

  10. Chicken Says:

    The Swiss voted to steal from the savers, no doubt Germans will to, IMO.

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