After a week focused on Republicans and the Fed, we turn to a week focused on Democrats and the ECB. While the DNC is little more than a side-show, it can provide some useful insight about broad policy in the months and years to come. The real story this week will be the EU Finance Ministers meeting and the ECB Governing Council meeting.
Political conventions are a lot of glitz and very little substance, but investors should watch for a couple things this week. First, if the Democrats are bold enough to release a deficit reduction plan to counter the Republican plan, it could provide an idea about the left and right bounds of the upcoming fiscal policy debate surrounding the fiscal cliff. Second, a strong conference showing from the Democrats further increases the odds of Obama winning reelection. His reelection means that the policies of the Bernanke Fed (including low interest rates into 2014) will continue. If the Democrats have a disastrous showing and begin a downward spiral in the polls causing a Romney victory, investors need to be aware that monetary policy will dramatically change at the end of Bernanke's term in early 2014 (note that this is before the forward guidance suggests rates will rise).
EU Finance Ministers
Although the meeting of the ECB Governing Council this Thursday is the main course this week, investors watching the Eurozone get an appetizer on Monday, the meeting of the EU Finance Ministers. Since markets have treated all statements coming out of Germany as functionally equivalent and not discerning between the distinct perspectives of the Bundesbank and the Merkel administration, I expect the Euro and European markets to see a nice rally on Monday. German Finance Minister Wolfgang Schäuble is considerably more open to ECB bond purchases than is Bundesbank President Jens Weidmann and any pronouncement to this effect will drive markets for a day or two before investors turn their full attention to the ECB.
ECB Governing Council
When the ECB governing council meets on Thursday markets will want to know three things:
- Does Draghi have German support?
- Is the ECB going to intervene in bond markets?
- What will bond market intervention look like?
I suspect Draghi will hint that the answer to the first question is now yes, but not say that before the German Constitutional Court ruling on September 12. This hinting is Draghi's stalling mechanism; if he doesn't hint, the markets will drop dramatically, but if he does hint, markets' response will be mixed.
Once again, I expect Draghi to indicate that the ECB is going to intervene in bond markets, but not as strongly as markets would like to see. This is another stalling tactic and one that will probably create a small rally on faith that the ECB will eventually act.
The trouble comes with the third question; Draghi is unlikely to provide any details about the bond buying program at the September 6 meeting. The Financial Times has reported that three committees of officials from European central banks have prepared different variations of a bond-buying program with the goal of coalescing round one plan for review by the governing council. So, we know a plan, or series of plans is in the works, but it is extremely unlikely that after having waited this long to get German support Draghi will try to pursue a plan before a German court ruling. What is more disconcerting is that if Draghi does push through a public plan on Thursday, this indicates that he does not think that the German court will side support the ESM, so he wants something in the works before the bad news. Since Draghi has provided a lot of talk and little action so far, it seems unlikely that he would flip the script now, so I expect him to hold off on any details about the bond-buying program.
Draghing Their Feet
Ultimately, the result of all this ECB watching will likely be that markets rally on hopes of an imminent program before retreating once investors realize that the slow pace of action at the ECB means we are in the same boat at the end of the week as we were at the beginning of the week.