Notes From Underground

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.

Tags: Art Cashin, ECB, Euro, Fed, Mario Draghi, Richard Clarida, U.S. Dollar

This entry was posted on April 10, 2019 at 6:52 pm and is filed under Currency, 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.