It was ECB President Mario Draghi who declared war on the German economic model of GROWTH THROUGH AUSTERITY, but it was the Chinese central bank that fired the first real shot in response to the “intervention” by Super Mario. As usual, Draghi proposed an increase in the ECB QE program (possibly in December) and also mentioned taking deposit interest rate even more negative. The EURO, of course, depreciated by as much as 3 percent while Draghi stoked the fires of a possible liquidity increase.
The PBOC wasted no time in responding by lowering its 1-year lending and deposit rates, as well as decreasing the threshold on reserves that Chinese banks have to hold. The Chinese let the world know that unlike the previous bouts of QE-led currency depreciation, the YUAN was not going to be the repository of transient global funds. The problem with QE as a tool of currency depreciation is that it loses its power as other nations respond by cutting their rates and adding liquidity to their financial systems in an effort to prevent a rise in the currency. The classic case of NIMBY (not in my backyard). So as the ECB tried to pursue a policy of currency depreciation to ignite economic growth, and possibly its inflation levels, the world doesn’t seem to be complacently accepting the desires of the ECB.
Again, the ECB used the virtual reality of JAWBONING but as of yet did not print one additional EURO. The media is awash with praise for how the Mario the Oratorical Genius has moved European bond yields lower, though I would not rush to that judgement. We don’t know if the ECB had saved its 60 billion of monthly bond purchases until the ECB meeting in an effort to give power to the words of Draghi. Without transparency of the ECB purchases all post-ECB press conference moves are based on conjecture.
The bottom line remains that the world’s central banks continue to destroy the signalling mechanism of the global bond markets. This week we will hear from three more central banks as the FED, Reserve Bank of New Zealand and the Bank of Japan all announce their interest rate decisions and provide some insight into how they each perceive the global financial landscape.
1. The FOMC announces on Wednesday and there is no press conference scheduled (yet). At Chair Yellen’s September press conference she suggested that the FED would announce a press conference if they were to raise rates. Currently there is no press conference but wouldn’t it be exciting if the FED surprised the markets and announced a YELLEN PRESS CONFERENCE for Wednesday. With Halloween around the corner a shock to the complacency of zero-rate dependent stock buyers would be a welcome fright and maybe restore some sanity to risk -based assets.
I would suggest that Ms. Yellen don her Volcker costume for the press conference. Oh, I must be thinking of Halloween’s past. The most interesting part of the FOMC statement will be the discussion about the recent strength of the DOLLAR and then to see how the vote breaks down. There has been so much dissension since the last meeting that a unanimous vote or even just one dissenter would be worthy of a skit on Saturday Night live;
2. The RBNZ announces two hours after the FED and is expected to hold rates steady at 2.75%. In September, the RBNZ cut rates by 25 basis points. Since then the KIWI has strengthened on all the FX CROSSES and 4 percent versus the Aussie dollar. If Chinese economic growth is moderating to the extent that some fear, the RBNZ may use the recent KIWI strength as a reason to cut interest rates again. The Aussie/kiwi cross may provide the best opportunity, but, as always, have your TECHNICAL levels in place for the best risk/reward trade.
3. On Thursday/Friday, we get the BOJ‘s interest rate decision,and, particularly a clue to the concept of more QQE, or large-scale asset purchases of various equities and bonds. There is much discussion as to whether Governor Kuroda will utilize this meeting for more asset purchases like the meeting in October 2014. I have been on record as saying the BOJ will not increase QE and weaken the YEN for it will only result in the Chinese exercising their power to depreciate the YUAN. Therefore, nothing will be gained but a further bloating of the BOJ‘s balance sheet.
The recent verbal intervention by Mario Draghi has caused the YEN to appreciate against the EURO but I still believe that Kuroda understands the politics of any preconceived effort to depreciated the YEN. Also, with the Trans Pacific Partnership trade deal coming to Congress the Japanese will want to defer any action deemed to be an overt act of currency depreciation. If I am correct, the NIKKEI may provide the best opportunity to trade as the response to BOJ INACTION should result in volatility in the equities.
***In tomorrow’s Financial Times there is an important op-ed article by Gideon Rachman, “The End of the Merkel Era Is Within Sight.” While the thesis of the article is based on conjecture of political outcomes, it is important from an economic perspective. As Rachman writes: “Ms. Merkel’s poll ratings are falling and far-right violence is on the rise. Der Spiegel … wrote this week that: ‘Germany these days is a place where people feel entirely uninhibited about expressing their hatred and xenophobia.'” Now, this is incendiary language in the political realm in response to the massive inflow of refugees but for my analysis it is the potential economic impact that we will have to be watching. As long as Chancellor Merkel was considered to be politically dominant she could provide support for President Draghi’s effort “to do whatever it takes” to preserve the EURO and the credibility of EU nations’ sovereign debt.
It was Merkel’s strength that get Bundesbank President Jens Weidmann on a tight leash as the voices of perpetual austerity were kept quiet. A weakening Merkel will not be able to counter the AFD and other euroskeptic Germans, especially as the huge inflow of refugees is aiding the anti-euro forces. This is a new situation that raises concerns for all the fringe parties cross Europe. Just when the seas calm, new headwinds arise.