Posts tagged ‘Mario Draghi’
In these uncertain times, let us refresh ourselves by beginning with what was again proved this week to be an indisputable fact: Mario Draghi is the most significant and successful central banker in the world.
The announcement three years ago that the ECB was assuming the power to intervene in bond markets, when he was not even 12 months into the job, put the sovereign debt crisis to bed, restored market confidence across the world and helped turn the creaking hull of the eurozone supertanker away from recession. Two years later his €400bn bank liquidity programme and adoption of a negative policy rate had analysts calling him a rock star. Another €700bn splurge and surprise rate cut followed. And at the beginning of this year Mr Draghi announced a €1.1trn programme of quantitative easing.
So yesterday’s announcement that the ECB was ready to modify the “size, composition and duration” of its QE exercise was part of a pattern. Draghi and team are being seen to do whatever it takes to re-normalise the eurozone economy. Indeed, as he put it at a speech he gave in London on 26 July 2012:
The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
Everybody believes you now, Mr Draghi.
Market reaction yesterday and overnight was, in a word, electric. The euro plunged by 1% against the dollar in the space of half an hour to close the day 2% weaker overall. (That is a more significant one day fall than the planned devaluation of the Chinese yuan that caused such consternation back in August.) The Euro Stoxx 50, which had been trading flat throughout the morning, rocketed up in the afternoon to post a +2.5% close. European bond yields hit new record lows: the 2-year bund was pricing at -0.35% in the opening hours of this morning while the 2-year Italian buono hit negative yield territory for the first time.
There is a good, detailed overview of the global impact of Mr Draghi’s latest star performance from Reuters here: Global Stocks Hit Two-Month High On Dovish Dragi Message. But it is the quotes from market observers which we will focus on before leaving this subject:
“Investors and traders are buying the idea of expected action out of the Bank of Japan and the ECB,” said Ben Le Brun, market analyst at trading platform provider optionsXpress.
The Chinese central bank’s injection of 105.5 billion yuan into 11 banks via its medium-term lending facility this week, combined with possible additional stimulus from the ECB, “may give the Fed more reason to raise rates by year end,” said Chris Brankin, chief executive officer of online trading platform TR Ameritrade Asia in Singapore.
“Draghi has come out and kitchen-sinked the whole thing, everything is now on the table,” said Gavin Friend, a strategist at National Australia Bank in London. “You combine what the ECB is now saying with (the fact) that the Fed is not going to be going aggressively and that the Bank of Japan is going to want to get involved, then you say ‘Blimey!'”
Mr Draghi has played his role exceptionally well, but the dominance of central bank rhetoric and activity over market behaviour is unhealthy. When the People’s Bank of China devalued over the summer for example it was treated as a disaster – a desperate act to prop up a seriously weak economy. The falling stock market in China had helped unsettle the world and the markets’ interpretation of events took place against a background of gloom. This week, however – thanks to the ECB – we inhabit an era of sunshine and optimism. So when the PBOC announced further monetary loosening today it was seen not as desperate but as a sign of “the government’s determination” which has now lit “a fire under global stocks” as “US equity futures jump”, to quote some of this afternoon’s commentary. Markets hated Chinese policy over the summer and loosening by the PBOC was taken badly; today it’s just what was needed to cement the rally in place.
If there is a cloud to go with this week’s silver lining, therefore, it is the now familiar truth that reliance on central banks has become a major source of volatility. “Money Markets Primed for Draghi as Bets Jump on Deposit-Rate Cut”, says Bloomberg’s headline today. And what if there is no cut on 3 December? Or if there is, but this is seen as bowing to market pressure – the kind of pressure which appears now to govern decision-making at the Fed? One day markets are given a boost by “Super Mario”, the next, they start looking for more – and pricing it in.
Volatility is the textbook definition of financial market risk. Mario Draghi is, to say the least, an impressive figure. He has given investors much to be very grateful for. But he and his confreres around the world, counter-intuitive though it might seem, have actually helped to make investing today a riskier proposition. To put it another way, we have become used to looking to central banks to underpin market stability; and by relying on them to the extent that we now do, ensured the exact opposite.
Markets barely had enough time to recover from Mario Draghi’s last “rock star” performance at the ECB before he shocked them with yesterday’s encore. Back in June he left his fans with the rhetorical question: “Are we finished? The answer is no.” Yesterday he proved it, lifting the lid on a plan for purchasing about €700bn worth of asset-backed securities while slicing another 10bp off policy rates. Only six of the fifty-seven economists and investment banks surveyed by Bloomberg expected the rate move, and the ABS programme, though trailed at the June ECB press conference, has also come surprisingly quickly.
Three months ago it looked as though Mr Draghi was playing to the crowd as much as anything. Two questions now emerge:
- Has anything substantial happened in Europe since June which has increased the need for emergency monetary measures?
- If not, how necessary are the ECB’s announcements as “open mouth operations”?
Look at the growth numbers reported in August and it is tempting to answer question (1) with a “yes”. Across the eurozone as a whole, GDP for Q2 was flat, down from an already-muted 0.2% rise in Q1. Stagnation in France was no surprise but it was a mild shock to see Italy back in recession. At the same time, headline inflation has continued to fall back with the annual CPI increase to August down at 0.3%. There has also been heightened concern in recent weeks over events in eastern Ukraine, with some commentators attributing weakness in European business investment to fears over escalating sanctions against Russia.
At the same time, however, it’s not that simple. The PMI composite indicator of economic output for the eurozone remains well into positive territory, despite the usual variation between countries, and the economic sentiment indicator (of consumer and business confidence) remains well off its 2012 lows – and indeed well above the levels associated with the three quarters of positive growth witnessed from Q2 2013. The ECB along with the consensus expects GDP to grow again this quarter, albeit at the accustomed muted rate. Even on the inflationary front much of the decline is down to cheaper energy prices: the “core” CPI rate for August, which as it excludes volatile items such as food and energy is supposed to be a more accurate reflection of the economy’s underlying price dynamics, actually rose for the second time since May to 0.9%. On balance, then, it does not seem reasonable to believe that there has been a material deterioration in the fundamental prospects for the eurozone over the last three months.
This does nothing to detract from the importance of question (2). At yesterday’s press conference (the full text of which can be read here), Mr Draghi had the following important, and in this blog’s view unarguable statement to make in the tangential final section of his answer to a question about fiscal policy:
[I]n many parts of the euro area, there are several reasons why growth is not coming back, but one of them is actually that there is lack of confidence. There is lack of confidence in the future, lack of confidence in the prospects, in economic prospects, of these countries.
It is an indisputable fact that much of the world’s confidence in recent years has relied for better or for worse on the perceived actions of central banks. The ECB understands this. And the reaction to this week’s news, together with one key longer-term trend, seems to indicate that they are getting the confidence-building part of their operation right.
First the reaction yesterday: Stoxx 50 up by 1.8% on the day, credit spreads tighter, euro back under 1.30 for the first time in over a year – in its biggest daily percentage fall against the dollar since the height of the debt crisis in November 2011 – and as for the bond market, well, that brings us on to the longer-term trend side of things.
Talking of the height of the debt crisis, back in November ’11 it cost the Italian government 7.9% to raise three-year money. A few months later, after the ECB announced its potential use of an emergency long-dated bond-buying programme, Italy was borrowing for ten years at 5.8%. Finally, just on Thursday last week, Italy raised ten year money at 2.4% and five year at 1.1%, record lows in both cases. And it isn’t just Italy. At the time of writing, two year bond yields are actually negative now in Germany, Denmark, Finland, Belgium, the Netherlands, France, Austria, Slovakia and (wait for it …) Ireland. It puts even the two-year Japanese government bond to shame, and makes the yield on our own 4% 2016 gilt look positively generous at 0.8%. All this is just excellent news, of course, if you’re an indebted sovereign looking to refinance your borrowing at the cheapest rates available in the world.
It doesn’t do to be complacent about Europe, or indeed the world economy in general. But it is encouraging that the ECB has been rising to the market’s demands for action in its own managed, but clearly credible way. European confidence in particular does indeed need all the help it can get. Rock star: play on …
Towards the end of July, Mario Draghi, President of the European Central Bank, promised to do “whatever it takes to preserve the euro.” For a few weeks, equity markets pushed slowly higher, the euro recovered some of the ground it had lost since the spring, bond market panic began to subside and observers watched nervously for the actual ECB policy.
Yesterday it was announced. The eurozone’s central bank will buy as much short dated government bond debt as it takes “to prevent potentially destructive scenarios.”
There are conditions attached. Bond purchases will be “sterilized” by offsetting the amount bought with liquidity reductions in money markets; in other words, the eurozone’s money supply will not increase. So this is not “quantitative easing”. In fact it can be seen as a corollary to Draghi’s last big move: extending ECB lending to the banking system out to three years last December (an operation which saw interest of almost half a trillion euros on day one).
What makes this necessary, of course, is the power of the bond market to kill economies and the impact this has had on confidence – in the more troubled eurozone countries, and across the world. Thus far Draghi’s announcement has served to consolidate rallies in “peripheral” eurozone debt: 5 year Portuguese interest rates have fallen from over 11% when he made his July announcement, to 7.1% on Wednesday, to 6.1% today; the 2 year yield in Spain has more than halved from over 6% to 2.8% over the same period; Italy’s ten year benchmark has come down from 6.5% to just over 5% – and so on. With luck, this will help turn confidence around in the real economy and allow the world recovery to pick up a little steam.
With luck, because this is far from being a foregone conclusion.
Firstly, there are those with the strongly held conviction that the euro is a concocted deadweight born of an aberrant political vision, irrevocably destined to collapse. For them, Draghi has wielded “a pea shooter rather than a bazooka”; and whatever anybody does now or in the future, “the eurozone is simply doomed.” Restoring confidence where there was none to begin with is an impossible task.
Secondly, confidence is a skittish thing. We saw this last autumn, when positive market reaction to the October talks in Europe was derailed completely by the announcement of a referendum on their outcome in Greece. That country’s emergency creditors are in Athens again this weekend, and will decide over the next few weeks whether or not to advance a further bailout tranche (due next month). Another disaster could very well impact sentiment again.
So good luck to Mario Draghi – but he’s not the only game in town.
This blog observed early in the year that economic data and market confidence were being pulled in two directions. On the one hand, Europe continued to drag along and threaten financial cataclysm. On the other, fear over a double dip recession in the US was unwinding rapidly and signs of improvement in the labour market in particular were giving markets encouragement.
Yesterday’s strong open in New York lifted European markets well above the levels they had reached while anticipating and reacting to the ECB’s rate decision and press conference. This was partly due to a stronger than expected US service sector growth indicator and stable data on unemployment insurance claims. Overnight, the combination of good news from the world’s most significant developed economies saw China’s Shanghai Composite Index rise by almost 4%.
The ECB got all the limelight yesterday. The defence of the eurozone from collapse remains a significant driver of market behaviour. But the failure of the US to grind to a halt is important too. Ultimately, we will know that confidence has truly returned when ECB press conferences aren’t making headlines all over the world.