Notes From Underground: Yes, Its Been a Long, Lonely Summer for Mario Draghi

It seems that the ECB has been the forgotten soldier in the war against deflation. When Mario and company packed their speedos and the latest research from the BIS and Tomas Piketty, the world became distracted by chaos and crisis other than Greece. Chinese devaluations and daily roller coast like movements in equity markets rendered Greece momentarily irrelevant, especially as Alexis Tsiparis captured the moment from the Greek referendum and steered a somewhat pragmatic course and thought to  placate the Greek center. Greek 3-year yields dropped 3500 basis points as investors bought short-term Greek sovereigns once the fear of GREXIT faded.

Yes, the ECB and its President Mario Draghi soaked up the quiet in Mykonos and let others deal with financial uncertainty. Tomorrow, the quiet ends as the ECB holds a meeting to determine its interest rates and provide guidance as to the future outlook for the EU economy. There is talk of improved economic performance but tepid would probably be an over statement. Unemployment across Europe is at 11% and inflation is measuring under 1 percentage point. The ECB‘s EU60 billion monthly purchases of various asset classes will be maintained for its promised duration through September 2016. In my opinion the ECB will hold its overnight rate at 0.05% and keep the bank rate on reserves deposited at the ECB negative.

The EURO currency is in the middle of its three-month range so while President Draghi would prefer a weaker currency the fact that it is rangebound and below the 200-day moving average probably provides little concern. The press conference following the formal announcement will give us some insight into Mario’s views on the recent financial volatility and will result in Draghi’s emphasis on the ECB remaining vigilante to any deflationary fallout from a slowdown in China and other emerging countries.

The U.S. unemployment data and the possible rate increase from the FED will provide the ECB some breathing room for if the U.S. dollar RALLIES on a strong jobs report then the ECB can be patient. The worst outcome for President Draghi will be if the DOLLAR fails to rally if the FED raises rates. I believe that would force the ECB to initiate new methods of weakening the euro. But with a G-20 meeting this weekend of finance ministers and deputy central bankers. I DOUBT MARIO WILL BE ANYTHING MORE THEN COY ABOUT FUTURE ECB INTENTIONS. Tomorrow’s ECB meeting and Draghi press conference will not be sealed by the kiss of any new monetary stimulus.

***Something to ponder and is certainly in the realm of 2+2=5. In contemplating the massive doses of FEDspeak that has saturated the airwaves and computer screens, I propose the idea of the FED raising the fed funds rate while cutting the interest on excess reserve (IOER) rate. The FED had not paid interest on reserves until it was implemented as an emergency measure in October 2008. By cutting the rate on excess reserves below the fed funds rate banks would stop placing excess money at the FED and would actually put the money to work creating velocity in the money figures and possibly stimulating growth. I know there are arbitrage problems for some money market participants but it is time to remove some of the emergency measures from the 2008 crisis.

If the FED is worried that a 25 basis or even 100 basis point FED FUND increase would harm the economy, remove the incentive for banks to hoard reserves. WHAT IS THE FED SO AFRAID OF? Anyway, the readers of NOTES are an intelligent, well-informed group so I put this out there to generate some thought. BUT I OFFER THIS: IF THE FED RAISED RATES AND CUT IOER, THE YIELD CURVES WOULD STEEPEN, SPOOS WOULD RALLY, DOLLAR WOULD WEAKEN AND GOLD WOULD RISE. I’m waiting to hear from the global voices of NOTES FROM UNDERGROUND.

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11 Responses to “Notes From Underground: Yes, Its Been a Long, Lonely Summer for Mario Draghi”

  1. Sarah Says:

    I hope so. Time to give something back to the little people!

  2. Asherz Says:

    Yra-Your suggestion that the Fed raise Fed Fund rates (anything more than .25 in two steps is out of the question) and lower IOER in order to stimulate bank lending and increase velocity makes a presumption. That is, that the only thing holding back banks from lending are these interest rate differentials. It assumes that borrowers are lined up to effect loans in order to build plants, infrastructure etc. and would send the economy on an upward trajectory.
    I don’t think that is the case. Corporate executives are not that sanguine about their longer term view of the economy and capital expenditures and hiring workers is not on their radar screen. The lending by banks would go to further asset inflation into overpriced, overvalued assets and allow the bubble to inflate some more.
    The rules of historical bank lending environment no longer hold in today’s world where global debt to GDP at near 3 to 1 has changed the rules and decision making in corporate boardrooms.
    Healthy economic growth will take place only when the liability side of the balance sheet returns to a healthy proportion.

    • Joe Says:

      Asherz-excellent. Especially on the point regarding the bank lending environment changing. (just as the bond vigilantes nave been vanquished by central banks) Today’s tighter credit standards would also restrict excess reserve credit from flowing into hands of consumers whose past credit balances fueled recent “growth.” That leaves the overflow “water” to find its level among the asset classes you refer to.
      The mortgage market gives us a clue as to the effects of tighter standards. Under old assumptions one might have guessed that 4% 30 yr mortgages would have already put the fly-over country market back where it was in 2008. Instead, ZIRP (with 25 bps on excess reserves) has, among other negative consequences, enlarged the sandbox for stock market and derivative speculators.

  3. Mike415 Says:

    Yra, great job as always. I wish i was well informed enough to comment on whether gold would rally or $ would weaken as a result of your thesis. What i would like to know is how you feel about equity markets in general right now after we’ve had a correction and more positive economic data. What are equity market trading opportunities? Thanks and have a great Labor day.

  4. asherz Says:

    Yra-Your suggestion that the Fed raise Fed Fund rates (anything more than .25 in two steps is out of the question) and lower IOER in order to stimulate bank lending and increase velocity makes a presumption. That is, that the only thing holding back banks from lending are these interest rate differentials. It assumes that borrowers are lined up to effect loans in order to build plants, infrastructure etc. and would send the economy on an upward trajectory.
    I don’t think that is the case. Corporate executives are not that sanguine about their longer term view of the economy and capital expenditures and hiring workers is not on their radar screen. The lending by banks would go to further asset inflation into overpriced, overvalued assets and allow the bubble to inflate some more.
    The rules of historical bank lending environment no longer hold in today’s world where global debt to GDP at near 3 to 1 has changed the rules and decision making in corporate boardrooms.
    Healthy economic growth will take place only when the liability side of the balance sheet returns to a healthy proportion.

  5. Dan DeRose Jr Says:

    Yra, As a faithful follower, challenge accepted. The idea of lowering IOER but raising the FF rate is a contradiction in terms but you might be onto something (I’ll get to that). The IOER was introduced as QE was undertaken b/c banks didn’t have a say in their excess reserves; the Fed dumped them on the banks in exchange for interest earning assets and the banks are stuck with them (in aggregate, to my knowledge, they can not be decreased unless the Fed sells assets). Today, the IOER serves the purpose of keeping rates off of 0 (just barely above) by allowing banks to arbitrage the FF cash market with the IOER. They can’t completely close the gap however b/c of FDIC fees (seriously) and balance sheet accommodations. This inability to get rates off of 0 is the reason the Fed introduced the o/n reverse repo facility. Now, their plan as discussed in the minutes is to have a corridor with IOER on the high end, o/n rrp vacuuming up the bottom end, and the effective somewhere in the middle. In a hike to .25-.50, the experts think the rate will settle in the low .30s. Now, if they hike but lower IOER, I don’t think the effective would increase at all but this is where I think you’re onto something. The very fact that a Fed rate hike from .14 to .33ish captivates market attention goes to show that it’s all about the market lens and not about fundamentals. A ‘lift off’ (not of a rocket but of a rate from .0014 to .0033) might certainly startle risk markets so they should take it slow. Hike rates from .14 to .14ish. It’s just like QE; it ‘worked’ without really working! Once they lance the boil, they’ll be able to have a little more flexibility without being the center of attention.

    Concerning market reaction, I agree with your thesis. If they’re able to delay I think it will be ‘game on’ for risk but I would caution any bullishness. In my opinion, the last Fed move was a tightening from ‘forward guidance’ to ‘you figure it out (kinda sorta… please don’t panic).’ You’ve already seen real rates increase to late 2010/2011 levels (in 5 yr and 10yr); that is a big tightening. Sure the Fed’s balance sheet is double late 2010/2011 levels but in this ‘what have you done for me lately’ world, I think the flow effect swamps the stock effect of their holdings. The market cares not for the favors of yesteryear. It kills me to say it, but if push come to shove, they better QE. Or, better yet, take this opportunity to stop this non-sense, lance the boil, raise rates, and tell Washington ‘your turn.’

  6. Donna Says:

    The thought of viewing Mario Draghi in a speedo is causing me more concern than thinking about China 🙂

  7. john doe Says:

    I doubt the fed funds rate matter much anymore since it is permanently affixed to the 0 bound. They may make some gesture of raising rates etc, but only to have a “bullet” as the economy surely is sinking.

    The importance however is on perception and psychology. The creation of a false omnipotence and control by our central bankers. The Fed like the Central Bank of Zimbabwe and Reichsbank has only one weapon and that is the printing press. When that realization spreads among the docile sheep slowly one by one, then in a deluge is the emperor truly naked.

  8. failedevolution Says:

    ECB’s economic hitmen

    http://bit.ly/1IXS23K

  9. kevinwaspi Says:

    All,
    Dan raises some very interesting issues, and gives us the tip of a very large iceberg of “unintended consequences” of a ZIRP. As an “old banker”, I can tell you that we are not trying to make our earnings on the 25bps IOER, nor would dropping it to zero make us approve more loan requests. Fact is, we approve good loan requests for the right reasons, DESPITE the 25bps, but what the omnipotent monetary policy gurus don’t understand is their inability to create DEMAND for money that is created from good quality loan requests.

  10. A.M. Look 9/3/15 | Says:

    […] yragharris.com/2015/09/02/notes-from-underground-yes-its-been-a-long-lonely-summer-for-mario-draghi/ […]

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