Jean Claude's Three Straws
Submitted by Alex Gloy of Lighthouse Investment Management
Will Trichet Be Removed Early?
Below is a list of the remaining events scheduled by the ECB before the end of the year.
It is a messy situation Trichet will be handing over to Draghi on October 31st. After the unnecessary rate hike in spring, what do you do:
- Cut rates in one of the remaining 3 meetings (see table), presenting Draghi with (almost) no room left to cut?
- Leave rates unchanged and risk being seen as a lame duck as the Euro debt crisis escalates?
- Agree to be removed early so Draghi can announce “his” first interest rate cut?
I am afraid it will be (3). The market will read it as a failure for Trichet and the Euro will get hammered.
And while the above is purely a thought experiment in outcomes and not probabilities, we superimpose it with the must read analysis we presented last week, from SocGen's Dylan Grice, on the options currently on the plate for the ECB, which has suddenly and quite dramatically taken center stage in the global central printing arena:
Suppose that Italy or Spain get caught up in the whirlwind like Greece, Ireland and Portugal, as threatened to happen last month. Maybe the Italian political situation deteriorates, maybe Ireland defaults, maybe Greece will go revolutionary, or maybe an ill-advised wayward comment from an influential European politician will spook markets and send them into renewed tailspin. We don't know which of these will happen, if any. All we know is that these are some of the many plausible triggers for a further deterioration in this fragile situation.
Let's say one of those triggers is activated, leading to an intensification in the runs on the securities of eurozone governments and banks, probably Italian and/or Spanish, but who knows? In all likelihood, every bank will get further pummelled regardless. And let's also say that the panic is fuelled further by concern that Italy and Spain's multi-trillion-euro balance sheet banks are simply too big for their already fiscally strained governments to save. Fear that they will try creates more panic in the market for those government bonds, the viability of the euro is perceived by the markets to be threatened and so all eyes switch to Germany and France to provide further bail-outs.
But then everyone realizes that France and Germany's own banks are being dragged down. And, in France and Germany at least these banks would take priority over those of other countries. So the trillion-euro bank balance sheets of many of the eurozone's financial institutions seem too big for even the core governments to save. Runs develop in the core government bond markets too as investors take fright that they might try. Meanwhile, the continued absence of any coherent pan-European political leadership ensures any opportunities to get ahead of the panic are missed, and so one/some European banks fail.
Thus the entire financial system fails. The 1931 Credit Anstalt crisis is rerun and the depression that follows is too much for austerity fatigued peripheral eurozone members, whose electorates succumb to the siren call of anti-euro populists promising deliverance from the economic misery imposed by Berlin. The euro ends not with a whimper, but a bang ....
Now, personally, I don't think this will happen. I think the ECB will get the printing presses rolling before we get to the stage where markets seriously panic over the solvency of the eurozone's core, or of its banks. And when I say I expect the ECB to get the printing presses rolling, I mean QE of the unbridled unsterilizable sort, and of which The Ben Bernak is so fond.
This action won't be taken lightly. In fact, I doubt it will be taken at all until the market puts a gun firmly to the ECB's head and forces it to choose between its two great loves: the euro or its Germanic belief in hard money. "You can't have both" the market will say, as it cocks its gun and slowly squeezes the trigger. And my guess is that the ECB will let its principles go and sell the strategy to Germans as a hard-money sabbatical. After all, if the hard-money Swiss National Bank can commit to unlimited money printing, so too can the ECB.
I also suspect such an action would be the final kick of the can. Money printing buys time and nothing else. But I think it could buy the eurozone quite a lot of time, certainly enough to be open-minded towards owning the cheap assets the episode might throw up. Let's face it, equities would likely become very cheap in the sort of panic that would force the ideologically Germanic ECB to print with the abandon of a Ben Bernanke.