Notes From Underground

This Mary MacGregor ballad released in 1976 notes how a woman is torn between two men she loves and it is “breakin’ all the rules.” This is the situation Federal Reserve Chairman Jerome Powell and the FOMC finds itself: The love of its dual mandate and its torrid affair with the beloved Phillips Curve. Now it appears that the FED leadership is abandoning its affair with Phillips Curve while it grows more attached to its other love, Mario Draghi and the European Central Bank.

Vice Chairman Richard Clarida has laid the groundwork to arrange the tryst with Mario Draghi as the FED‘s research has revealed that the yield differential between the U.S. and Europe can only diverge so far before it will harm the U.S. economy.

This week brings another ECB rate decision with President Draghi entertaining the financial media with a magician’s deft touch with a jester’s success of obfuscation. (NOTE: I doubt the ECB will cut rates although we may hear about some effort to increase corporate bond purchases or open market buying in European equity markets. So no rate cut but enhanced QE.)

It won’t matter to the FED for the tryst has already been consummated via Powell’s Paris speech, New York Fed President John Williams’ remarks on Thursday and Clarida’s interview on Fox Business. The New York Fed on Friday tried to walk back the impact of Williams’s remarks, referring to the speech as academic, but there can be no undoing. Especially when Williams said “current estimates of neutral rates in U.S. around 0.5%.”

The because of the walk-back, precious metals, bonds and the yield curves — along with the dollar — rolled back Thursday’s price action. Even the S&Ps saw a late selloff as the market began to accept that the FED’s next action would be a TEPID 25 BASIS POINT CUT rather than the 50 basis points the market sensed on Thursday.

For Notes From Underground, it’s not an issue of a 25 or 50 CUT but the larger significance that the FED‘s policy has become unmoored from its long-held models. The DUAL MANDATE IS DEAD AS IS THE PHILLIPS CURVE, a difficult situation in that the FOMC has made a $4 trillion investment in what they admit is a flawed compass for  navigating the sea of liquidity created by the world’s central banks. As always, I maintain that it is GOLD‘s sense that the central banks are adrift in a fiat currency world. To those that posit that GOLDBUG is a pejorative concept I rebut with the wonderful piece by Jim Grant in Barron’s about the success of the PhD standard of monetary policy. I ask, WHAT IS A FIAT CURRENCY BUG???

***Two areas of  concern while I was on hiatus:

First, there have been several articles hinting at a direct intervention by the Trump administration into the currency markets. In a Financial Times article from July 11 said “Goldman Sachs has become one of the highest-profile investment banks to warn that there is a growing risk the Trump administration will intervene in the currency markets in a bid to weaken the dollar.” Later in the week Pimco analysts issued a similar warning, as did other global banks. It is certainly something to be vigilant about because the talk is coming from some administration sources;

Second, a separate FT article from July 11 discussed the issues with a disappearing bund market. This is an issue we’ve discussed in Notes and with Rick Santelli as a reason to be long BUNDS but short other European sovereign debt in its place. In the workings of post-financial regulation, there is a natural need to own the highest quality liquid asset, THE BUND, a difficult proposition when Germany is running budget surpluses and the ECB currently owns a large stockpile. As the article confirmed, bunds “are the eurozone’s benchmark safe asset. If there are not enough of them around,banks could run short of high quality collateral for lending, while the ECB will struggle to find enough bonds to buy if it wants to revive its quantitative easing programme to combat a downturn.”

This is a very serious issue as it will force President Draghi to either violate the Capital Key rule of the ECB’S QE program and force the ECB to buy GERMAN equities/or corporate debt, or maybe even Deutsche Bank stock. If the ECB is LYING about the construct of its balance sheet in regards to the capital key, look for German citizens to head back to the German High Court for some resolution. That will again open public critique of the ECB policies and elevate the stature of Bundesbank President Jens Weidmann. Christine Lagarde is inheriting a potential firestorm.

Is the only way out a EUROBOND created by consolidation of the ECB balance sheet?

Torn between two lovers also applies to Europe. The lack of credibility for any central banks is a liability not directly on the BALANCE SHEET.

Tags: Christine Lagarde, dual mandate, ECB, Eurobond, Federal Reserve, Jerome Powell, John Williams, Mario Draghi, New York Fed, Phillips Curve, Richard Clarida

This entry was posted on July 21, 2019 at 10:38 am 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.