Notes From Underground

Sorry. The current situation in the European Union has been well forecasted by NOTES FROM UNDERGROUND so until the storm clouds clear and the Italian ruling coalition begins to initiate some of its campaign proposals I treat everything in Europe as a trade and not an investment. Even the talking heads are waking up to the potential financial damage that bank balance sheets loaded with ZERO RISK-WEIGHTED sovereign bonds can cause a healthy bank’s bloated balance sheet.

On Monday, the Financial Times had a very good article detailing the European commercial banks’ exposure to Italian government bonds (“Italy Turmoil Shows Banking ‘Doom Loop’ Still A Powerful Force”). As I stressed many times at Notes From Underground, the entire European project rests on Germany’s desires. Will the German electorate acquiesce in providing the financial wherewithal to create a harmonized fiscal system and a EUROBOND to compete with the U.S. Treasury market?

The problem is that ECB President Mario Draghi has put into place the ability to create a EUROBOND. This has been the subterfuge of the massive QE program, which has been prolonged far beyond any genuine economic necessity. The political rationale may exist but the as the heightened financial repression of the German voters has done harm to the government of Chancellor Merkel.

The weekend press was filled with several articles discussing Merkel’s recent rumblings about Germany doing more to invigorate the entire European economy. But there will be pushback from the more right-wing elements of Merkel’s own party, and, of course, the Bundestag opposition group, the AfD. On Tuesday afternoon, Bundesbank President  Jens Weidmann said in an FT story, “ceding a significant portion of their sovereignty to Brussels is precisely what the Euro area members are not prepared to do. It seems to me that it’s already hard enough at times to ensure that the European Commission’s existing powers are enforced and respected.”

This is a statement from an ECB board member who is being seriously considered as the next President of the ECB. In my opinion, the Germans will not compromise, UNLESS A GERMAN IS MADE THE NEXT HEAD OF THE ECB. German voters will be averse to backstopping the ECB without a greater sense of control.

During Tuesday’s trading session the EURO CURRENCY staged a strong rally upon the release of a rumor reported by Bloomberg that the ECB is said to see June 14 as a live meeting to debate the QE exit. From the story: “President Mario Draghi’s Governing Council is likely to treat the June 14 gathering in Latvia as a live opportunity to debate winding down bond-buying ,said the officials,who asked not to be named because such matters are CONFIDENTIAL,” (emphasis mine).

This Bloomberg story is irresponsible as it won’t name the sources so anybody can move a market enough to cause volatility and make a few rubles. I am skeptical of this although I don’t doubt it will be debated for a minute. The question will be what will Mario Draghi reveals at the press conference.

The Italian situation has already created a black eye for Draghi as he has been accused of intruding on Italian politics by failing to fill the quota of Italian bond purchases when Italian yields were spiking. It’s doubtful that the ECB will want to further kick the hornet’s nest of political populism. To add further doubt the veracity of the BLOOMBERG story, I offer up the opinion that for the past year Reuters has seemed to be the source of ECB-quality leaks.Bloomberg rushed to get out ahead and drove the get away car for some financial miscreants.

***Another must-read in the FT: “Fed’s Dilemma Grows More Acute After EM and Europe Turmoil,” (Joe Rennison and Robin Wigglesworth). This is an argument that has validity and raises the issue about the FED having a triple mandate because of the position of the DOLLAR as the world’s reserve currency. The current Governor of the Reserve Bank of India, Urjit Patel, said, “Given the rapid rise in the size of the U.S. deficit, the Fed, must respond by slowing plans to shrink its balance sheet. If it does not Treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.”

This is a critical outlook for its cites the critical issue of a three-pronged attack on liquidity, which may be the cause of the dramatic flattening of the U.S. yield curve. If the FED wishes to reduce its balance sheet it ought to refrain from raising the FED FUNDS rate until it has some sense of the impact from the draining of reserves as Treasuries roll off. Peter Boockvar and Jim Bianco have raised this issue during the previous months  but the concern of the RBI’s Patel should give a heightened sense of concern at the Powell Fed. Let the digressions continue.

Tags: Angela Merkel, balance sheet unwind, ECB, Euro, Eurobond, Fed, Germany, Italy, Mario Draghi

This entry was posted on June 5, 2018 at 6:19 pm and is filed under Debt Market, ECB, Europe, Fed, Germany, Italy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.