Markets are geared up for Thursday's ECB meeting. Mario Draghi lifted market expectations of more monetary policy with his speech in Jackson Hole. Strange, since the ECB's cards are on the table given its policy blitzkrieg in June, i.e. negative depo rate, TLTRO and future ABS purchases. One could make the case that he is running out of rabbits to pull out from his hat.
Yet the beast must be fed. Markets will not tolerate a non-event. Perhaps the ABS program is pulled forward, or perhaps he will lower rates further. I thought his Jackson Hole speech was more about policy, that monetary policy cannot do it alone and needs to be supplemented with looser fiscal policy and structural policies. A besieged central banker crying for help. However, from a market standpoint that is too academic and distant.
Super Mario will pull through. We've seen this song and dance so many times. He truly is the maestro when it comes to massaging expectations. Also in terms of market reaction the policy details don't really matter… One should not say that, but it's the truth. As long as he delivers or brings forward measures that according to some strange metric crafted by the gods of the market place are deemed sufficient. Also note that promises of future action and such are good currency too. Our game is one where expectations often trump actualities. This is not to trivialise the relevance of promises and future plans. After all what are market prices but discounted cash flows weighed by conditional probabilities?
On Main Street it does matter what type of monetary measures are brought forward. The key point is that the Eurozone is different from the US. Finance is transmitted via banks and not bond markets. It's the reason vanilla government bond QE a la Bernanke is inappropriate. Instead the ECB needs to revitalize its moribund banking sector through more direct measures. TLTRO and ABS are reflective of this reality. One sometimes wishes Frankfurt would just capitalise the banking sector and be done with it.
Although the headline inflation print of 0.3 % looks alarmingly low almost the entire decline has in fact been food and energy prices. Core inflation has held steady at just below 1.0 %. In addition after a drop the 5y5y inflation rate - a measure of inflation expectations - has remained anchored near the ECBs 2 % target. The euro has fallen against the dollar and bond yields - especially Bunds - are ridiculously low. One can make the case that whilst we are all European alarmists now, its economy is actually being supported on the down low. Equilibrium forces are at play.
Despite fear mongering the real downside is perhaps not of going Japan, but of a long weak recovery. Boring, but plausible. Japan remains a tail risk scenario, no more. This makes certain sectors such as Eurozone banks very attractively priced recovery plays. Not exactly an ingenious global macro trade, rather just transposing what worked in the US on Europe.
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