Notes From Underground

Three years ago I wrote a blog suggesting that Bundesbank Axel Weber should become ECB President so that the Germans felt they had control of Europe’s monetary policy. My argument was simple: If the Germans controlled the ECB then Berlin MAY BE more willing to support a QE program. As Bernard Connolly argued 20 years ago, the French hoped to gain control of European monetary, thus remove the powerful influence of the Bundesbank. The French have worried that an ECB under the influence of German monetarist restrictions would favor tight money and with it a strong EURO. France and Italy have relied on the ability to depreciate their currencies during times of stress but a Bundesbank-infused ECB would be more reticent to follow the path of least resistance and the possibility of inflation.

In 2011, President Sarkozy outmaneuvered Chancellor Merkel and was able to elevate Mario Draghi to the ECB presidency rather than Axel Weber. IT HAS BEEN A GIANT MISTAKE. It is time for Mario Draghi to offer a compromise to the Germans and this is it: The ECB DOES A MASSIVE QE. DRAGHI RESIGNS AND A GERMAN BECOMES PRESIDENT OF THE ECB. A GERMAN IN CONTROL WOULD SILENCE THE CRITICISM EMANATING FROM THE BAVARIAN BURGHERS AND WOULD PROBABLY GET THE SUPPORT OF GERMANY’S TOP DECISION MAKERS. President Draghi can return to Italy to serve in a high position where he may have the political influence to hope alleviate Italy’s terrible economic situation. The French will consider themselves odd man out but the reward would be a genuine QE program with  all the trimmings: low interest rates, banks relieved of non performing loans and maybe a weaker EURO currency.

If the December 5 piece by Ambrose Evans Pritchard has any validity, this proposal is a possibility. Pritchard wrote that the ECB executive council was split about QE with three members opposing President Draghi. The voters in opposition were Germany’s Sabine Lautenschlager, Luxembourg’s Yves Mersch and France’s Benoit Coeure. It’s very surprising that the French opposed the Draghi QE plan. As Evans-Pritchard noted, “The clash comes at a delicate moment amid Italian press reports that Mr.Draghi may soon go home ….” It seems that the POPE was talking about President Draghi when he called Europe old and haggard. So, if you are going home Mario seize victory from the jaws of defeat by invoking the Notes From Underground Plan and reaching a compromise for the possible benefit of all of Europe.

The Germans can be persuaded to accept by Draghi pointing out two facts to Jens Weidmann and Chancellor Merkel. First, The EUR/YEN CROSS is  at 149 is going to cause stress for German exporters. Secondly, the 2/10 German yield curve is at multi-year lows, around 75 basis points. It is certainly a bull flattener as investors buy BUNDS. Regardless, the German curve is indicating economic slowdown. It is time to call the question for ECB and Europe for German opposition to QE is certainly understandable for it is its citizens who will provide the credit backstop for any ECB monetary relief.

As Ambrose Evans-Pritchard states so beautifully: “The euro means a single government and a European superstate, and implicitly the abolition of Germany as a fully sovereign independent state. To pretend otherwise is intellectually infantile. To resist this truth-yet to proceed doggedly with EMU anyway–merely condemns Europe to rolling crises and permanent depression.” Mario, go home with dignity and let the German’s become the monetary masters of the Monetary Union. QE MAY BE AN EXISTENTIAL ISSUE EITHER WAY.

***Thoughts on Friday’s unemployment data. The non farm payrolls for number were a robust 321,000, and, more importantly, the average hourly earnings increased 0.4 percent. The results for the FED WILL BE THAT THE FORWARD GUIDANCE LANGUAGE OF “FOR A CONSIDERABLE TIME” WILL BE REMOVED FROM NEXT WEEK’S FOMC STATEMENT. It is time for the Fed to take off the market’s training wheels and become data dependent. The market seems to believe this  for the 2/10 and 5/30 curves have made new lows as the curves flattening in anticipation of the Fed bringing forward an interest rate increase. The FED‘s projections for an interest rate rise have been sooner than the credit markets but Friday saw a 11 basis point rise in the December 2015 fed funds contract, which is a sizable move without a FED announcement.

The market is beginning to accept the possibility of a mid-2015 lift off in rates, just as Vice-Chair Fischer and New York Fed President Bill Dudley suggested last week. The violent movement in the short-dated interest rates reflected the market lagging behind the Fed’s analysis. It is a good time for the Fed to become data dependent and stop being chained to a calendar and risk falling well behind the curve. Regardless, the market action suggests that the FED is preparing for change but of course that will be subject to many variables,including the nineteen elements on the dashboard of Yellen’s Labor Market Conditions Index. Next week’s FED meeting looms large for the credit and interest rate markets and certainly the dollar.

***There are elections in Japan on Sunday, December 14 and the LDP coalition and PRIME MINISTER ABE are expected to prevail. The markets will be concerned about the size of ABE‘s victory and whether or not he lost some ground in Parliament. The YEN had a rally today as the DAX and SPOOs had sizable down days so some position squaring provided for a bid in the EURO and YEN. In my opinion, the EUR/YEN cross is an important indicator for ECB monetary policy for it is German exports versus competition from a depreciating Japanese yen. It is the Germans and Japanese who are the most direct competitors in the global export arena. A short-term positive for the Japanese economy is the drop in OIL prices and I again advise readers of NOTES FROM UNDERGROUND to pay attention to the CRUDE/YEN spread.

Many years ago falling oil prices were a positive for the Japanese current account and thus the YEN, but since the massive BOJ stimulus plan the market has paid little notice to the price of OIL in YEN. When Governor Kuroda surprised the markets with an increased QE plan on October 31, it was the deflationary impact of falling crude oil prices that provided the rationale for countering its deflationary potential. If the BOJ is now on the sidelines for further QE, lower oil prices may begin to have a somewhat positive effect, especially if the Europeans actually initiated a substantial QE program. Also, if the ABE election results are stronger than previous it may lead to renewed discussion about reinstating some of the mothballed nuclear plants. As Tobias Harris continually reminds us, the Japanese polls show that its voters are not in favor of a full return to nuclear power.

Tags: Abe, Axel Weber, ECB, elections, Eur/Yen cross, Europe, Fed, France, Germany, Japan, Mario Draghi, QE, Stanley Fischer, William Dudley

This entry was posted on December 8, 2014 at 7:49 pm and is filed under BoJ, ECB, Europe, Fed. 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.