- The ECB did the unprecedented last month in moving to negative interest rates.
- While European equities initially traded higher on the news, they have since sold off.
- Many of the largest banks are trading significantly lower, not typically a good sign for the broad markets.
A month ago, the European equity markets roared with approval when Mario Draghi and the ECB did the unprecedented, lowering the deposit rate to -0.1%. For the first time in history, a major central bank moved interest rates to a negative level in order to "spur lending and spending."
Lending and spending. The thinking is simple. If you punish banks with a negative deposit rate, they will be more inclined to lend it out to households and businesses. Also, a lower deposit rate for banks means a lower deposit rate for individuals, prodding them to spend their money rather than to save it for a rainy day with the prospect of little or no return.
Sounds terrific in theory. Of course, what is completely lost on these "policymakers" is that their solution to the problem was the proximate cause of the problem: too much debt, lax lending standards, and overspending.
But that's another article for another time.
Today I want to focus on price action in Europe since the interest rate decision on June 5th.
After an initial surge higher, European equities have traded definitively lower, with the most notable weakness occurring in the Financial sector (NASDAQ:EUFN). (click to enlarge)
Digging within the sector, we are seeing losses in some of the highest profile banks, with Deutsche Bank (NYSE:DB) leading the way to the downside, hitting new 52-week lows.
Many will argue that there are idiosyncratic issues (fines, increased regulation, etc.) at play and not to read anything into it as the S&P 500 (NYSEARCA:SPY) is still near an all-time high. That may very well be the case, but from a stock market perspective, you rarely want to see banks lagging to this extent, as it often can be a precursor to a more difficult market environment.
What will Draghi and his "policymakers" do in response should this weakness in European Financials continues? Whatever it takes, if we take them at their word. They discussed an ABS purchase program at the June meeting and have not ruled out a full-scale quantitative easing in the future.
That has been the modus operandi of central bankers globally over the past few years. If a policy does not appear to be working, never assume that the policy itself is flawed; you just need to do more of it. And that begs the question: if negative interest rates are supposedly a boon for the economy and are without risk, why stop at -0.1%? Why not move the deposit rate to -10% or start a program to randomly confiscate any cash that is not lent or spent?
Well, perhaps that is coming in the not so distant future, if we take Draghi's "whatever it takes" at face value.
Mario Draghi, July 2012: "The ECB is ready to do whatever it takes…believe me, it will be enough."
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