There is so much in the political realm that proves the concept of 2+2=5. I will continue the analysis of the impact of politics on markets but remember there is so much political tinder that can ignite the fires of market volatility. A quick sample from over the weekend can be found in Europe where local elections in Frankfurt, the home of the ECB, resulted in large gains for the AfD right-wing party. More dramatically, a small Neo-Nazi party won 17 percent in one district. Support for Merkel’s party, the CDU, and her coalition partner SPD, dwindled. This weekend’s regional elections in three German states will probably result in more losses for the Merkel government. Again, as bad as the refugee problem is in Germany it seems that the monetary policies of the authoritarian ECB and President Draghi are causing greater angst among the German population. Negative interest rates in Germany continue to repress German savers, resulting in a loss of confidence in the established political elite.
The spillover to the BREXIT vote will be realized if the mainstays of the EU project continue to suffer from the disillusionment of their electorate. The Eurocrats’ ability to generate growth is hampered by the Maastricht Treaty and its emphasis on fiscal rules that result in a financial straitjacket to rival the GOLD STANDARD that caused great problems for governments trying to throw off the yoke of the 1930’s global depression. The Germans would never have allowed for the huge expansion of the European Union without the strict Maastricht rules thus setting up the situation for the ECB to be the standard-bearer for combating the entrenched stagnant economy. The struggle for Europe is that the ECB is the irresistible force meeting the Bundesbank, the immovable object.
This collision course is the major problem confronting Merkel and Draghi, which makes this Thursday’s ECB meeting so important. During the past week the ECB BOARD MEMBERS ARE ATTEMPTING TO WALK BACK EXPECTATIONS FOR MORE QE SO AS TO PREVENT A REPEAT OF DECEMBER’S MARKET RESPONSE TO THE STATEMENT. (It was well below market expectations, which led to a selloff of sovereign debt and a 4 percent rally in the EURO currency.) Be careful as Draghi may try to get more done now as the political tail winds are becoming headwinds. From a TECHNICAL perspective the EURO has resistance at the 200-day moving average (CQG–110.47).
***Today, JPMORGAN was quoted in a Bloomberg article by Eshe Nelson titled, “Europe’s Peripheral Bonds Are A Steal.” The bank’s London CIO Nicholas Gartside claims Spanish and Italian spreads can halve in the next 12 months. I presume he means relative to German debt because of the ECB’s QE program. The concept is correct as a trade but I WOULD NOT MAKE THIS INVESTMENT. My logic is simple and should be a concern for your portfolio. The payoff for taking this credit risk is just not worth it. If the BRITS leave and other EU voters push for more referenda, the debt of the peripherals is going to suffer. Add in Merkel’s slipping poll ratings and the risk/reward is not worth it. Revisit the sovereign debt markets from 2011 -2012 to get a qualitative view of the potential fallout after the Bundesbank gaining increased influence over ECB policy.
Yes, JPMORGAN is correct on a relative value play but from a risk/reward analysis I would not go chasing this whale. But the entire premise of this relative value trade is based on the FACT that the world’s central banks have broken the signalling mechanism of the world’s bond markets. Wonder why the GOLD has so out performed in the realm of the Humpty Dumpty central banks. (See my February 1 appearance with Rick Santelli on CNBC.)
***From the G-20 meeting comes the essence of political dissonance. On Friday there was a WSJ article by Takashi Nakamichi titled, “Global Pressure Gives Japan Few Options to Weaken Yen.” It seems that Taro Aso, Japan’s finance minister, misunderstood European concerns over the weakness of the YEN. Mr. Aso informed the Japanese Parliament that Mr. Dijsselbloem was misquoted about Brussels’s concern with the Yen’s value and its depreciation leading to a global currency war. As Mr. Nakamichi writes in response to Mr. Aso: “A European Council spokesman told the Wall Street Journal earlier Mr. Dijsselbloem’s comments had been reported accurately. Japan’s Ministry of Finance declined to comment later Friday on the content of G-4 discussions.”
It seems that certain parties failed to get the message from the meeting in Shanghai. This finger-pointing against Japan was certainly supported by the Chinese and makes this situation reminiscent of June 1998 when the FED intervened to buy YEN just as President Bill Clinton was heading to Beijing. The Chinese were irritated by recent efforts by Japan to depreciate the YEN during the height of the Asian contagion crisis of 1997-98. The YEN had dropped by almost 30 percent during that twelve-month period causing pain for some Asian economies as the Chinese claimed the Japanese were exporting deflation through a depreciated yen. In an effort to PLACATE the Chinese, Treasury Secretary Robert Rubin reversed the STRONG DOLLAR mantra and ordered the FED to BUY YEN AND SELL DOLLARS. Complicating the politics was the fact that President Clinton did not inform the Japanese and provided a greater slight by not stopping in Tokyo.
The difference of opinion emanating from the G-20 should be of greater concern because of the Japanese moves on Friday. The markets learned that the BOJ’s Governor Kuroda was replacing a voting dissident with a more friendly QE and negative interest rate source, Makatu Sakurai. The BOJ’s recent NIRP vote was a 5-4 vote in favor so Kuroda needed to improve support for the newest contentious policy. Take that Dijsselbloem! When searching for certainty in the global financial world, be smart and remember 2+2=5.