Notes From Underground

After the Swedish Riksbank’s decision on Wednesday to keep rates at -50 basis points and pledging to raise rates in the coming months, the Bank of Canada met market expectations by raising its overnight rate by 25 basis points. The most important information from Governor Poloz is that the BOC raised rates even though last week’s inflation data was much softer than expected. The BOC official statement noted that the global economy is solid, the reconciliation over the USMCA is positive and “rates to rise to a neutral stance to achieve inflation target.”

Another central bank follows the FOMC language in evoking a neutral stance. It is very disconcerting that the central banks all adopt similar language even though most of the developed economies are not in sync with each other. Similar policy responses to divergent economic cycles is what has created a cacophony of mispriced global assets. At least we know that Mario Draghi will have to address problems unique to the ECB and its economic arena.

The political turmoil in Europe coupled with recent weakening economic data leaves the market expecting NO CHANGE to current policy. The QE program remains at 15 billion euros until year-end and overnight deposit rates at NEGATIVE 40 BASIS POINTS. The Draghi press conference begins at 7:30 a.m. CST. Expect there to be many questions about Italy and the condition of European banks laden with Italian bonds. President Draghi will confirm that with rates this low there is no threat of financial risk to the European system as the ECB has “done a great job in deleveraging bank balance sheets.” The ECB will say the solution to the Italian budget problem is an issue for Brussels and European Financial group. Mario will shift the focus to the need for fiscal reform across the EU to meet the obligations of the Maastricht Accord.

There could be two surprises from Mario which could buoy equity markets: 1. The ECB could mimic the Bank of Japan and announce a stock buying program because of the lack of debt available to meet the requirements of the capital key. The ECB will not be shrinking its balance sheet as QE ends and will seek to repurchase fresh assets as the current ones expire. The ECB could own high quality European equity on a euro-by-euro basis. This may be running afoul of EU law but what is law when the program to save the EURO is called whatever it takes; and 2. The ECB can “recommend” a massive infrastructure program in an effort to pick up the economic slack in an overall slowing European economy.

Remember, it will only be a suggestion for Brussels to adopt fiscal stimulus measures, especially as the German model of fiscal restraint is under attack from several European nations. The bottom line is that Merkel is badly wounded politically so this is the chance for Macron to try to find commonality with the Italians in an effort to push forward his agenda. Any hint of a fiscal stimulus program would be positive European equities. Be patient and allow the press conference to reveal the tricks of Mario the Magnificent.

***The president was on the attack (yet again), challenging and cajoling the Powell Fed for continuing to raise interest rates with every positive piece of economic data. In a Wall Street Journal interview on Tuesday, President Trump noted: “To me the FED is the biggest risk, because I think interest rate are being raised too quickly.” This is of course a falsehood because the pace of the Powell Fed is moderate. If I was Fed Chairman, the FED FUNDS rate would have been at 3 percent last year. Then I would have held the rates steady so as to measure the impact from positive real yields.

Jerome Powell is slowly rising rates in an effort to move the FED to a more “neutral position” with the immediate impact being a diminution of over extended asset prices. The impact from the FED is that risk premiums are rising to a more realistic level, especially in response to cash earning more then NOTHING. Also, in the interview President Trump noted: “I am very unhappy with the FED because Obama had zero interest rates.” Larry Kudlow, the President’s key economic adviser, OUGHT to inform his boss that he can have Obama zero interest rates too when the economy returns to a very TEPID rate of growth. The problem, Mr. President, is that when you gloat about your economic policies causing robust growth (like, +3 percent GDP), then the cost of money is going to increase as demand increases as the market responds to the added stimulus. Mr. President, as the leader of the world’s key democratic capitalist society you have not been granted the authority to rescind the laws of supply and demand. Before you retire tonight, I suggest you read Paul Volcker’s Bloomberg column. Then you will know what economic stewardship means.

OK, Mario,now we await you tomorrow. Time for some major feats of prestidigitization.

Tags: ECB, Euro, FOMC, Jerome Powell, Mario Draghi, QE

This entry was posted on October 24, 2018 at 4:32 pm and is filed under ECB, Fed. 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.