Notes From Underground: Mario the Magician Has Lost His Assistant

The Bank of Japan did not surprise the markets as they remained committed to the lunacy of QQE, even with positive growth for many years. In an effort to make the central bank’s policy ever more relevant the BOJ lowered their inflation expectations, which the markets interpreted as lower for longer, resulting in a flurry of YEN selling of against all of the major traded currencies. There was even movement in the Swiss/yen cross as both central banks battle to keep their currencies in check by keeping interest rates negative.

The ECB will announce its interest rate decision tomorrow morning (6:45 CST) with a Draghi press conference to follow at 7:30. Market consensus is for no change with the main rate to be kept at zero and the deposit rate to remain at NEGATIVE 40 BASIS POINTS. As usual, the press conference will be KEY but since the bond buying is over look for Draghi to avoid the questions about when the ECB plans on raising rates. President Draghi will dance around this issue by reiterating concerns about tariffs, Brexit and a slowing China plaguing the global economy. Draghi will make his typical plea for European nations to increase fiscal stimulus so that the ECB is not the only game in town.

On Wednesday, German Chancellor Merkel delivered a speech in Davos in which she challenged Draghi by stating that monetary policy “should return to normal as soon as possible.” This was pure political posturing because it has been Merkel running interference for Draghi in his efforts to do whatever it takes when preserving the EU financial system. Merkel knows full well that the European economy is slowing and that French President Emmanuel Macron is under pressure from the weekly demonstrations of the “yellow vests.” All in all, this was an ill-advised speech by Chancellor Merkel as she OUGHT to have avoided Davos at all costs. One of the significant issues at Davos this year has been the growing disparity in wealth and income over the last ten years.

Bloomberg published an article titled, “Davos Billionaires Keep Getting Richer,” which revealed that “the fortunes of a dozen 2009 Davos attendees have soared by a combined $175 billion even as median U.S. household wealth has stagnated.” The numbers for Europe–where growth has been much slower–would probably be worse if the data had been broken out.

By aggressively supporting Draghi, Merkel has played a prominent role in the financial repression of the European middle class, while also pushing for fiscal austerity for the debt-burdened economies of Europe (Greece, Ireland, Spain, Italy and Portugal).

The Chancellor OUGHT not be taking a victory lap while the streets of Paris are filled with demonstrators protesting against the Brussels and French elites. Merkel couldn’t resist playing to the Davos crowd by sticking her finger in President Trump’s eye again. Per Bloomberg: “The German leader laid at least part of the blame for mounting economic risks with `disruptions and uncertainties’ in multilateral institutions, a veiled swipe at the unpredictable leadership of Trump.” Is this really the time for Merkel to be baiting the President of the United States with a German industry worried about auto tariffs and Brexit?

So on Thursday Merkel will leave President Draghi to fend for himself and the result will be: Europe’s inflation is well below the 2% target so monetary policy will remain accommodative until the target is reached. In response to the self-defined ECB mandate/target I adhere to Paul Volcker:

“No price index can capture, down to a tenth or a quarter of a percent, the real change in consumer prices. The variety of goods and services, the shifts in demand, the subtle changes in pricing and quality are too complex to calculate precisely from month to month or year to year. Moreover, as an economy grows or slows, there is a tendency for prices to change, a little more up in periods of economic expansion, maybe a little down as the economy slows or recedes, but not sideways year after year. Yet, as I write, with economic growth rising and the unemployment rate near historic lows, concerns are being voiced that consumer prices are growing too slowly–just because they’re a quarter percent below the 2 percent target! Could that be a signal to “ease” monetary policy, or at least delay restraint, even the economy at full employment? Certainly,that would be nonsense.”

On Thursday, if you stomach listening to Mario Draghi you will hear a great deal of what Volcker calls nonsense. In laying out the history of this inflation targeting Volcker attributes its birth to the Reserve Bank of New Zealand and Governor Don Brash from 1988-2002. But, as Volcker explains, New Zealand is a very small, open economy.

Paul Volcker cites this piece of knowledge: “The old belief that a little inflation is a good thing for employment … lingers on even though Noble Prize-winning research and experience over decades suggests otherwise. In it new, more sophisticated form it seems to be fear of deflation that drives the argument.”

Listen in and be careful of the ALGO headline readers driving EURO currency volatility along with the European bonds. Draghi will say little but generate a great deal of discussion. Be patient and have your levels in place ahead of the press conference. Remember, even though the ECB‘s quantitative easing program has officially ended BUND yields have dropped. Quality is to be bought when the differential is not worth the added risk.



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8 Responses to “Notes From Underground: Mario the Magician Has Lost His Assistant”

  1. asherz Says:

    Yra- let’s take a look at three concepts touched on in your, as usual, excellent piece today. Deflation, QE and income disparity.

    Deflation- Is it a good or bad thing. In the 19th century with massive industrial and technological advances, prices of products kept coming down, making them affordable to the many. Standards of living went up so that by the mid- 20th century the average American family was better off than the nobility in prior centuries.
    However in the last 30 years with the buildup of debt, with over $60 trillion in new debt created since the Great Recession alone, with a 320% Debt/GDP ratio, deflation today is a huge black cloud that would topple our financial system. All self inflicted by our alchemists.

    QE and Income Disparity- Actually these two are connected, one resulting from the other. The 2008-9 meltdown brought in the financial firefighters. There were two alternatives. One, let the perpetrators of the mortgage mess go down in flames and bring the whole economy with them which would cause much short term pain, but eventually return to equilibrium, or bail the perpetrators out. The Fed, whose members belong to those that would have been wiped out, of course chose the second option. But they kept the bailout going,,,and going,,,and going. The trillions of QE creation did not go mainly into infrastructure spending, corporate capital expenditures and anything that would be the foundation for future growth. Much went into buying assets: stock buybacks, real estate and the like. This made the owners of those assets wealthier-really wealthier. Many billionaires were created. The middle class? Not much. This was the TRICKLE UP theory. And not so much of a trickle but a deluge up.
    So now we have yellow vests, populists across much of Europe and Alexandria Ocasio-Cortez here with 70% tax rates, The pitch fork crowd is soon to follow. But Capitalism, a 250 year phenomenon which produced the greatest middle class growth and rise in living standards is now seriously threatened, as its accompanying political system, Democracy. The 1920s punchbowl party led to the 1930s, and in Germany we see what happened to that democracy and its horrendous results.
    The Davos beneficiaries of the last ten years have good reason to be concerned. And so should all of us.

    • yraharris Says:

      Asherz—bingo ,bango,bongo—yes and the deflation which you note is also a big part of the Volcker issue of maintaining a 2% inflation target—the 1937 crowd of bernanke have scared the world.Yes,Japan has certainly been the newest”paradigm” but they remain an interesting study because of their huge savings when they entered their terrible 25 years but actually not bad as a society.Volcker’s article supports the basis of why GOLD is a solid investment–not the fears of inflation but the fear of deflation and how central banks will lose control of the balance sheets they have amassed.Wealth inequality is and will be a serious issue and it a regular concern of global capitalism and the free flow of money around the globe.The skimming of profits not by the entrepreneurs beloved by Schumpeter but by the custodians of corporations is enough to bring back the memories of the movie Casino —but al least they knew the outcome if caught.The question still remains unasked on CNBC,FOX Business and Bloomberg—how does wall street make so much money??Don’t look under the safety blanket of the pernsions

      • Asherz Says:

        Yra-In the next global slowdown (has it already started?) and debt service becomes dangerously tight, how will the Central Bankers react? Will they keep a steady hand on the till and try to navigate a controlled deflation, or will they use their primary tool and give the Gutenberg machine a QE on steroids? A rhetorical question.
        Inflation or more likely hyperinflation will result. And following your investment advise, GOLD , will make the holder a survivor. And if deflation then follows or deflation is where we go initially as you posit, the yellow metal will still be the life preserver as the fiat ( “In God We Trust”) currency will give the holder of the greenback understanding that He is the one that should have been trusted rather than the cockeyed captains steering the ship.

  2. Arthur Says:

    Venezuela. Your insight? Thanks.

    • yraharris Says:

      Arthur–this is a very delicate situation.If Maduro holds it could get very bloody quickly.The Russians and Turks came out this morning in support of Maduro so of course the UN will be a non-starter so it looks like the Monroe Doctrine will be the US backstop.As far markets,the Venezuelan heavy crude which is not refined by all nations—PDVSA refiners are citgo –it will take awhile to turn around the devastation of the oil industry.alo,Venezuela has sold much of its gold and it owes large amounts of money to China and Russia.The positive is that maybe Latin America can straighten this out themselves before the streets are flowing with blood–it is always the people who suffer at the hands of all authoritarians and Venezuela is no different.Trump did take the lead and then others have followed but let see who else lines up–maybe the Davos crowd has a concern other then the need to buy cheap Venezuelan debt—amazing that Europe is very quiet on this

  3. TripleNet Says:

    Thanks to QE, US banks are holding 130% reserves to demand deposits. They are highly capitalized. The next “Lehman moment” is most likely going to come out of the EU, not the US.

    In case readers missed it, Germany’s industrial production fell by a whopping 4.7% YoY in December, the biggest decline since December 2009!

    The Central Bank of Russia disclosed its latest holdings of FX reserves as of 2Q18. Russia accounted for 90% of the inflows into the Chinese bond market in 1H18. Staggering figure.

  4. David Mann Says:

    Yra, To be a successful trader, one must be disciplined and fearless. You and Asherz have nailed down my greatest concerns and fears of the past 9 years. Its going to be tough putting fear back in the closet…maybe have to take a week off trading! Thank you both for putting it succinctly in writing.

  5. Rohr (Alan Rohrbach) (@MacroMeister) Says:

    Hi Yra-
    In the wake of the Draghi disquisition it appears to be back to ‘bad news is good news’ in a way we had not seen for a while.

    What else explains the tandem bid in the US equities, all govvies and the emerging currencies in the face of so much global economic weakness and political disruption? Kind d of interesting that the ECB & BoJ accommodation are driving the US ‘portfolio cure channel’. Not really a surprise, yet interesting nonetheless.


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