Notes From Underground: Draghi Is Waiting On a Sunny Day

President Mario Draghi’s press conference proceeded as expected as the European Central Bank laid out its plans for dealing with a slowing global economy suffering from the slings and arrows of president Trump’s trade war threats against the Chinese and now the Europeans. The ECB plans on keeping its interest rate policy intact through 2019 and probably longer as it confronts the recent headwinds to growth. The media asked several times about the possibility of tiering of rates in an effort to remove the adverse impact from the NEGATIVE DEPOSIT RATE FOR RESERVES PARKED AT THE ECB.

One journalist came very prepared and asked Draghi if the negative flow for European banks versus the positive income flow for US banks was acting as a drag on the European financial system. Large European banks have to PAY the ECB to deposit excess reserves at the ECB while in the U.S. the FED is paying about 2.40 PERCENT to banks that place reserves at the FED via interest on excess reserves (IOER) rate. The well-prepared interlocutor said the cost to EU banks was 7 billion euros while U.S. banks were the recipients of almost $50 billion from the FED‘s program.

The answers from Draghi suggested that the ECB was still studying the overall effects of negative rates. But after listening to Mario Draghi I am certain that a tiered system will be in place by June. If this proves correct, then European bank stocks should be a buy as they have taken a beating from the ECB’s monetary policy. The ECB held firm in its DOVISH stance, which caused the EURO to sell off versus a basket of currencies, but by the New York close the EURO had pared most of its losses and actually closed HIGHER versus the DOLLAR. Pay close attention to this close for it can be a signal that the DOLLAR is setting up for a correction. The FED minutes were released at 1:00 p.m. CST and there was very little to move the markets.

A greater possible drag on the dollar may have been the Richard Clarida speech on Tuesday night at a Fed Listens event in Minneapolis. The Fed Vice Chairman appears to be the provider of dovish sentiment as he has previously advocated for a patient FED because of the headwinds arising from a strong dollar, weak foreign economies and the rising concerns about geopolitical uncertainties. In his prepared remarks, Clarida had a dovish tone yet again as he again advised patience while the FED analyzes its current policy in an ever-changing environment.

Three key take aways:

  1. “The short-run Phillips curve appears to have flattened, implying a change in the dynamic relationship between inflation and employment.” A flatter curve means the FED can be more patient as a sustained rise in inflationary pressures is less likely;
  2. The issue of “flexible inflation targeting,” in which the FED acts to adjust the inflation target upward after long periods where inflation persists below the GOLDEN 2%. The flexibility invoked by the FED would assuage the deleterious effects of “inflation expectations become poorly anchored or become anchored below the stated inflation goal; and
  3. The resultant policies to an inflation or employment shortfall would be the use of “makeup strategies” in an effort to rectify adverse policy outcomes.

The FED appears to be concerned about its failure to meet inflation goals when interest  rates are at the effective lower bound. It all seems to point to a policy of lower for longer and, more importantly, to MAKE UP rules in a constant desire to search for counterfactuals to justify a dovish policy stance. The more Clarida speaks, the more certain that the FED is trapped by the continued efforts of the world’s central banks to keep downward pressure on their currencies through the use of continued monetary stimulus. Clarida provides clarification.

***Thank you to Art Cashin for the kind reads for NOTES FROM UNDERGROUND. In his DAILY MARKET COMMENTARY, Art picked up some of Tuesday night’s commentary on Draghi and Europe. Art is one of the great sources of wisdom and the reason I continue to watch CNBC when I know when he appears. It is time to turn up the volume when either Cashin or Santelli has market commentary. Thank you, ART.

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8 Responses to “Notes From Underground: Draghi Is Waiting On a Sunny Day”

  1. TraderB Says:

    The Fed thinks that the correlation between average wage and inflation has decoupled. They are correct. Seems like the relationship between change in median household income and inflation is pretty spot on. Interest rates should be around 1.75%. On par with CPI and Growth in median household income. Doesn’t this data indicate rates in the US are too high? Maybe EDZ19 – EDZ20 for -30 ticks isn’t so dumb after all.

    • yraharris Says:

      Trader B–interesting view but maube the 19/21 dec eurodollar is eveb better for will the Fed raise rates in a presidential election year???how many times in the presidential cycle has that occurred

      • Don H Says:

        A month ago, Chairman Powell claimed that he couldn’t be fired by “45”. Raise rates and then keep a close eye on your Twitter feed IF you want to test that belief.

        Yra,
        Great “Notes” as usual…Thanks!

      • TraderB Says:

        If we get a low CPI print in the next month or two (1.5 or lower), I don’t see how they can wait until 2020 to cut. Just making the point that the growth in average wages is not nearly as important as the growth in median income. Unless you think Jeff Bezos buys 100,000X more milk, meat, and vegetables than the rest of us.

  2. the bigman Says:

    Yra For the uninitiated, can you explain how the ECB tiered system would function and which banks would benefit the most Also if you could expound on the significance of the 19/21 dec eurodollar which I assume is a futures spread and where we can follow this. Thx

    • yraharris Says:

      Bigman–the tiered system would be derived by having a system where banks would not all be treated the same when depositing overnight reserves at the ECB—presently the overnight rate is -40 basis points in an effort to get banks to lend rather then leave funds at central bank–hasn’t worked and the cost to European banks has been significaant as reflected in equity valuations so in a tiered systemrates would be set by whatever criteria the ECB comes up with in an effort to relieve the unintended punishment–TLTRO in backbreaking punishment out—-we will have to wait for the exact specs but it will be important but again not a tightening–the onerous situation is having unintended consequences less bank income less lending —remembereurope is much more bank financed then corporate bonds so important.The 19/21 spread in the december eurodollas is not my trade as I am looking at the dec.20/21 spread because of the election cycle as their is a tendency for the FED to shy away from raising rates before Presidential elections,meaning a low probability.Those involved in the 19/21 spread are actually looking for a rate cut in this year which although I believe should be done for unconventional reasons with the present administration—dollar strength is a drag for the global financial situation because of the vast amount of debt and I believe that this is what makes Richard Clarida a dove—but at this juncture I just don’t see that so not looking to do the 19/21—hopefully other readers will add their opinions

      • the bigman Says:

        Thanks Yra So in a tiered system ECB can choose winners and losers among EU banks sounds vaguely familiar: the name Lehman Bros. comes to mind Nice tool for a Central Banker to keep unruly countries in line.

  3. Chicken Says:

    Will we discuss the effect/distortions (+/-) IOER creates?

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