Notes From Underground: Draghi Checks; Will Yellen Raise?

Mario Draghi failed to deliver any new stimulus from the ECB and his press conference was very low-key in presenting any form of tweaks to the programs in place. Draghi adopted the posture of all the global central bankers by invoking the “counterfactual clause,” which maintains that all the QE efforts are successful because things would have been much worse had the ECB sat idly by and watched the mass liquidation of assets. In response to a question from Financial Times reporter Claire Jones, Draghi noted the greatest result of the “whatever it takes”pledge to be the harmonization of interest rates within the EU. The compression of interest rate spreads have resulted in significantly lower borrowing costs for Italy, Spain, Portugal and all the other debt-stressed nations. Ms. Jones also inquired if the ECB was worried about shortages of asset classes to purchase for its balance sheet. Draghi: “For the time being changes are not substantial and monetary policy is effective.”

Some analysts thought Draghi would push for the ECB to BEGIN purchasing individual bank bonds, which would make the ECB a creditor of the banks of which it supervises. This would have essentially tossed a lifeline to the Italian banks and ended the issue about creditor and depositor bail-ins. President Draghi did what all central bankers are doing and pushed for legislators to put forth fiscal stimulus and structural reforms. The most perplexing component of the ECB complacency was that Draghi noted that the threats were to the downside on both growth and inflation as the economic recovery was “dampened by foreign demand.” And yet Mario checked.
WHY? When analyzing the markets’ response by the close I am left with this SUPPOSITION, which was put forward by ERIC of Vine Street during our discussion yesterday. IF THE ECB DOES NOTHING THEN THE FED WILL RAISE AT SEPTEMBER’s FOMC MEETING. I thought this was an interesting idea but doubted its possibility. But as I monitor the late prices of various asset classes this view gains more credibility. The DOLLAR, which had sold off following the lack of new stimulus, has rallied to close higher on the day. Precious metals were sold. U.S. equities–in spite of strong energy and banking stocks–are weaker. U.S. interest rate futures have been sold, violating some significant support levels. European sovereign debt futures were also sold even though the ECB is still buying 80 BILLION EUROS of assets for the next seven months. The only outlier was the failure of the 2/10 yield curve to FLATTEN. However, if the curve does begin to FLATTEN during the next day or two I believe the idea of a FOMC move in September will have LEGS.

I have believed that the FED ought to have been raising rates during the previous two years but they missed the opportunity. There are many analysts opining that the John Williams school of thought is gaining ground at the FED: Raise now so there is room to move when the economy sputters. (The Williams/Reifschneider paper that deals with the need to be able to have higher rates so as to be able to respond to a slower growth outcome.) I will again make this point: Is Yellen afraid of losing control of the FOMC, so she’s willing to abide by another raise to avoid a 7-3 or 6-4 vote at the September meeting?

Things are indeed muddled, between Stanley Fischer hinting at a possible two rate rises before the close of 2016 and Goldman Sachs strategist Jan Hatzius’ 55% probability of a September rate rise. Draghi may have held fire because an FOMC increase could drive the DOLLAR higher, leaving the ECB more room to respond to any renewed turmoil in the EU. The board has responded for the moment but let us watch to for any continued momentum to support this hypothesis. Draghi checks to Chair Yellen with the strongest hand at the table.


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17 Responses to “Notes From Underground: Draghi Checks; Will Yellen Raise?”

  1. Frank C. Says:

    Jefffrey Gundlach of Doubleline had his conference call today.

    He stated that rates are going higher. He possibly see the 10 year in low 2% by end of the year. Possibly hitting 2.2%. He is very defensive and very short duration.

    Firmly believes that rates bottomed on July 6-8th 2016. We will not see those lows.

    Also made the case that fiscal stimulus is in the air, which is not good for rates.

    He made the case that the dollar does not strengthen on a rate hike. Instead it sell’s off.

    His analysis of negative interest rates was that it doesn’t work.
    Stating it is a “Triumph of hope over experience.”

    • yra Says:

      Frank–thanks for the heads-up.If it is the curve steepening as the long end going going higher then I agree with Gundlach but it is case dependent and in the zero interest rate environment previous fundamental analysis may not hold.When the FED raised rates last December the 2/10 was at 129.0 and now we are pressing at the critical low of 75 basis points—yes negative interest rates don’t work and are merely the ultimate tool of financial repression .NIRP results in pushing on a string as savers hoard as interest income twindles or as Keynes would note the paradox of thrift–but I prefer Schumpeter’s theory of pushing on a string

  2. ShockedToFindGambling Says:

    Yra- i think that the market action may have been predicated on the belief that the U.S. economy will strengthen.

    The transportation index, theoretically a leading indicator, completed a major bottom yesterday, and held well today, even with the oil rally.

  3. Chicken Says:

    Perhaps a tactic on Draghi’s part to assist the process of instilling fear in Italian citizenry considering a vote against reform?

  4. david Says:

    If Draghi goes number one but Yellen goes numero dos, I think this means the FED WILL RAISE in Sept. lol

  5. costaselgreco Says:

    Surely a couple of quarter point hikes are not going to be enough ammo to fight a downturn of the cycle. Back in the Greenspan and Bernanke days, rate cuts were significant and did have an impact on the economy and the markets. If it is true the Fed has eyes on the stock markets as a symbol of the improving wealth effect, why would it risk crashing them?

    • yra Says:

      Costa—I agree with you but the world’s central bankers are searching for some sense of finding their way as they have lost and are losing the credibility of major voices—they have painted themselves in a corner and the complacency of equity investors and bond buyers has compounded the problem.Global growth is not strong enough to support the high valuations and the fear factor of risk takers could send the economy into a downturn

      • Chicken Says:

        Thus if the FED were to hike rates, perhaps aggressively even, they will have room to move once the markets do crash (as a response to FED hiking rates).

        Sounds like the same criminal pump and dump executed circa 2008

  6. costaselgreco Says:

    Thanks Yra. Sounds like you are suggesting the quest to restore credibility in central banks by hiking (and possibly crashing markets) may be necessary, and I guess reputation is important if jawboning remains a central Fed policy tool. But how many people think Fed presidents talking everyday in contradictions is doing them and the markets a favour? To me they dont even sound like they are doing policy; they’re just manipulating markets for the benefit of the fastest HF traders…in other words the banks that employ them.

  7. Frank C. Says:

    Dovish fed governor Lael Brained talk will be a pivotable moment.
    If she flips to a slightly less dovish stance this will be very noteworthy.

    I like others believe she has Janet’s ear more than Stanley.

    Yra, I know you stated you can’t make it to her Chicago speech, but you can pick it up here

  8. ShockedToFindGambling Says:

    Long end of curve falling apart again…..2/10 steepening. Economy will crater if bond market gets out of control…… FED needs to tighten aggressively to decrease inflationary expectations and cushion long bond fall…..but they won’t.

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