Excerpted from Doug Noland's Credit Bubble Bulletin, [21]
Mario Draghi has ascended to the status of the world’s most powerful central banker. Amazingly, he leapfrogged even Ben Bernanke back in the Summer of 2012 with his machismo “do whatever it takes.” Along with the BOJ’s Kuroda, the ECB grabbed the QE baton from the Fed and haven’t looked back. Unlike Kuroda and Yellen, he’s a “market guy,” even serving a stint as a Goldman Sachs vice chairman and managing director.
Market participants began falling out of love with Mario Thursday. Until then, he’d been the central banker equivalent of the Wall Street darling growth stock CEO that reliably always beats earning estimates. For the first time, Draghi was a major disappointment. Only two weeks ago he confidently assured the markets he had the quarter (oops, the meeting and QE growth) in the bag.
November 20 – Financial Times (Claire Jones): “Mario Draghi has dropped his clearest hint yet that the European Central Bank is about to inject more monetary stimulus into the eurozone economy, brushing aside staunch opposition from Germany’s powerful Bundesbank. The ECB president said yesterday that ECB policymakers would ‘do what we must to raise inflation as quickly as possible’. The remark echoed a promise Mr Draghi made during the region’s debt crisis in 2012 to do ‘whatever it takes’ to save the single currency.”
Thursday’s wild market reaction to Draghi recalled the many instances over the years when growth stocks were obliterated on an earnings miss. How many times have we heard some variation of, “How could the stock drop 15% when earnings only missed a penny? This is an obvious market overreaction!” Usually, however, those selling down 15% don’t regret exiting. The single penny earnings miss tends to be a harbinger of worse things to come. It often marks an inflection point in the “story” – the beginning of the end of the game. With company management no longer able to “manage” predictable earnings growth, the sophisticated players and momentum speculators want out. While down big on misses, at least there’s usually big trading volume to accommodate sellers.
Draghi has been playing a dangerous game. He shot from the hip in 2012 and then forced his radical policy course down the throats of the ECB governing council. He stoked a historic Bubble in European bonds and equities, then essentially dared the ECB hawks (certainly including the Germans) to crash the party. Over recent years he’s become the Alan Greenspan of global central bankers: The hero and clever maestro. Mario the policy and market genius. In the nineties, the speculator world was content to bet on the Greenspan market backstop. These days, why rely on Kuroda or Yellen when Super Mario’s got your back.
Along the way, he’s attracted quite an adorning crowd – or at least a crowd of Crowded Trades. Euro devaluation has been one of the greatest ever gifts to financial speculation, ensuring the euro short has become one massive Crowded Trade. ECB QE and the resulting historic collapse in euro-zone yields have spurred Crowded Trades throughout European bonds and equities. Draghi’s “whatever it takes” has been an albatross around the necks of the Swiss National Bank, ensuring ultra-loose monetary policy and a Crowded Trade short the Swissy. Similar pressures on the Scandinavian central banks have ensured similar consequences. Only God knows the amount of leverage that has accumulated throughout European fixed income. For that matter, how much liquidity (and leverage) has flowed from Europe into U.S. securities markets? How much to Eastern Europe and EM more generally?
I have serious issues with contemporary central banking. Somehow, it has become accepted policy to openly manipulate and inflate securities markets. It’s the role of central bankers to dictate “market expectations,” just as over the years they’ve seen a crucial role in shaping so-called “inflation expectations.” Crucially, monetary inflation these days feeds “inflationary expectations” throughout securities markets. And as “money” has continued flowing into global market Bubbles, central banks have lost only more influence on inflationary dynamics in real economies.
In the face of Trillions of QE over recent years, commodity prices have collapsed and general consumer price inflation throughout much of the “developed” world has drifted downward. Global central bankers have nonetheless adopted Draghi’s “whatever it takes” to ensure “inflation” reaches their “mandate.”
After the August “flash crash” – global market dislocation – central bankers again convinced the markets that they were willing and able to do “whatever it takes”. And as energy and commodities have come under further pressure (along with consumer price indices), expectations grew that more shock and awe was on the way. It’s a fool’s errand. Draghi, Yellen, Kuroda and others talk “inflation mandate” and markets hear endless “money” to inflate securities markets. And the more global Bubbles have inflated the more emboldened financial players have become of QE Indefinitely.
Draghi promises to ‘do what we must to raise inflation as quickly as possible’ – and then delivers no increase in the size of monthly QE purchases. There was no awe – only shock. Tellingly, markets cared little about negative rates or an extension in the QE program. Flashing indications of latent market vulnerability, participants were demanding more “money” and they wanted it now. Draghi’s Friday talk of a “no limit” ECB balance sheet must have Weidmann and responsible members of the ECB at their wits end.
It’s the nature of monetary inflations that there’s always a need for more. Throughout history, it’s been ‘just one more round of ‘printing’’ or ‘just one more year and then we’ll rein things in’. But things spiral out of control – and there’s a lot of currency with a lot more zeros. It can end in hyperinflation, at least when monetary inflation is afflicting the real economy. Today’s strange variety is inflating securities market Bubbles. It will end with Bubbles bursting and confidence collapsing.
Integral to the bursting Bubble thesis is that policymakers are losing control. Granted, such analysis has about zero credibility when markets are in melt-up mode. But perhaps the markets’ response to Draghi is a forewarning.
A headline from Friday’s Wall Street Journal: “Crowded Trades Collapse: U.S. stocks, bonds and the dollar all tumble as popular trading positions are hit by the ECB.” And Friday evening from the WSJ: “Macro Hedge Funds Caught Off Guard by ECB’s Move.”
I’m sticking with the view that unstable markets will continue to pressure de-risking and de-leveraging. With currencies moving 3% in a session and the bond market succumbing as well to wild volatility, it seems obvious that players will have to respond by ratcheting down risk and leverage. It remains a self-destructive backdrop with way too much “money” chasing limited securities market opportunities. Popular trades now come with unfavorable risk versus reward.
I believe global markets are back in high-risk territory, and fragilities wouldn’t be as extreme if global policymakers had allowed an overdue market adjustment to run its course back in August.
Markets rallied on notions of QE forever, while the fundamental backdrop continued to deteriorate.
The commodities rout has worsened.
Brazil has taken a turn for the worse.
Meanwhile, fragilities continue to fester in China. Efforts to stabilize a faltering Chinese stock market Bubble have stoked even greater bond market excess. Authorities are cracking down hard on the securities industry with troubling ramifications for faltering financial and economic Bubbles.
Here at home, an acutely imbalanced economy beckons for (an inauspicious) “lift off.”
The geopolitical backdrop turns more alarming by the week.
And now, with only about four weeks left in the year, inflated confidence in global central bankers has sprung a leak.
