In the famous 1951 sci-fi movie, an alien with a ROBOT has the power to threaten the entire Earth and bring human civilization to an end. The only words that can prevent the ROBOT (algorithms) from the total destruction of the world are: KLAATU BARADA NIKTO. Let’s hope that tomorrow ECB PRESIDENT MARIO DRAGHI has those same words at his command. There is so much riding on tomorrow’s ECB decision and the press conference that Mr. Draghi can bring financial ruin to the global money system. In all prior press conferences Draghi has been able to calm markets with mere promises of future actions. The game of securing time in an effort for improved economic performance is over.
The Swiss National Bank removed any sense of calm that Draghi previously provided and the market is demanding genuine action. In the many years of trading and investing I HAVE NEVER BEEN SCARED OF POLICY ANNOUNCEMENTS BECAUSE I COULD DEVELOP A GAME PLAN based on research and use of charts of price action to get a sense of potential outcomes. Tomorrow’s ECB decision has some many potential possibilities that it is too difficult to assign probabilities of market outcomes.
Complicating the situation tomorrow is the enormity of positions,as most investors are SHORT THE EURO in great anticipation of the ECB policy driving its currency lower through the use of a massive QE program. Not only are investors massively short the EURO but global funds are long European sovereign bonds in the hope of further compression of yields by continued central buying of debt instruments. Today–and everyday this week–there have been rumors of the size of the QE program and its make-up. The lead de jour with the greatest impact was that the ECB would begin to purchase 50 BILLION EUROS of bonds and other assets beginning in March through December 2016. This would calculate to about ONE TRILLION EUROS of purchases and bring the ECB‘s balance sheet back to its previous high threshold of THREE TRILLION EUROS.
This rumor was strong enough to cause the SPOOS, GOLD, and the U.S. Treasury market to rally, though the GOLD and TREASURY rallies faded by the end of the day. Mario Draghi may have over promised the markets through planned leaks in an effort to undermine the German intransigence about quantitative easing (aka large-scale asset purchases). If President Draghi fails to deliver it will be difficult for the markets to remain rational. The markets will not act like the report in “The Day The Earth Stood Still” (per Wikipedia): “In response GORT [the robot] relented from destroying the Earth and resurrected Klaatu from death.” For President Draghi, failure to perform on the issue of QE will lead to destruction of billions of dollars and euros because of built -up expectations.
What’s complicating the landscape for Mario Draghi is the SNB‘s action last week and the continued fall-out from the Swiss acting in contravention to the market’s reliance on the forward guidance of a respected central bank. Again, the market is heavily relying on the ECB‘s integrity so there is much to be scared about. Mario, KLAATU BARADA NIKTO.
***Other issues complicating tomorrow’s decision by the ECB:
- GOLD. The metal has rallied nearly 10 percent since January 1 in a very deflationary environment, which provides warning signs that global investors are disenchanted with central bank policy. This has been my argument for two years, that gold is not an inflation hedge at this juncture but a haven against central bank malfeasance and fiat currency. (See John Plender in today’s Financial Times.)
- BANK OF CANADA. The central bank “unexpectedly” cut its interest rate by 0.25 % to 0.75% and in stating the reason for the BOC decision, Governor Stephen Poloz said: “Given the magnitude of the shock to oil prices, there is an EXCEPTIONAL AMOUNT (emphasis mine] of uncertainty about the profile” for inflation. The BOC has joined the Danish Central Bank and the SNB in cutting interest rates to offset the fears of too rapid a disinflation.
- The German DAX and other European equity markets have rallied strongly in the last two weeks in anticipation of some type of aggressive action by the ECB. The equity rallies have been supported by the drop in European sovereign bond yields to record lows as Spain, Italy and Ireland all have 10-year yields below the Unites States. If Draghi disappoints European equities will drop and the yields on some of the peripheral bonds will rise in dramatic fashion.
The issue for the QE package and bond yields will be dependent on how much sovereign debt the ECB buys versus how much ASSET-BACKED SECURITIES (ABS). Remember, it was six months ago that Mario Draghi raised the issue of the ECB purchasing private bank non-performing loans in an effort to unclog the credit pipelines that fuel European credit creation. The ECB may mimic the FED‘s QE3 program in which the FED bought $85 billion a month evenly divided between U.S. Treasuries and MBS. Buying large amounts of ABS may be the more important element of the QE policy because it will allow the Germans to be placated as the national central banks will buy their own sovereign’s debt and the ECB will purchase the private sector. The purchase of private sector ABS will not be in violation of the EU treaty as it is not directly bailing out any nation.
There is so much to consider in regards to the ECB decision so again … I am scared. Heed my advice and not be a hero and let the market move in violent ways before committing to any strategy. Let us hope that calm prevails for Tomorrow Will Not Be The Day The Markets Stood Still. Mario, BARADA NIKTO.