Via ConvergEx's Nicholas Colas,
We were in the room for European Central Bank President Mario Draghi’s speech on Friday in New York and came away with three observations.
First, commodity price deflation is more of a threat to the Eurozone than it is for the U.S. economy given the differentials in current economic growth. That means the future of direction of oil prices will inform ECB policy more than that of the Federal Reserve.
Second, his repeated use of the term “calibration” – the ECB’s version of “Data dependent” – reminded market participants to watch actual inflation trends rather than just central bank rhetoric. That, to his mind at least, was why capital markets were mispriced ahead of Thursday’s ECB meeting.
Lastly, the era of central bank “Rock stars” is far from over – there were about 1,000 people in the room, or more than any corporate CEO or most politicians could ever hope to draw. And, like all great rockers, President Draghi knows his audience and delivered a market-moving show.
Walk into the building at 55 Wall Street, and even the most jaded New Yorker would have to be impressed. The exterior looks like a Greek temple, complete with huge columns made from single pieces of granite and topped with Ionic capitals. Inside, the ceiling is four stories tall and modeled after the Pantheon in Rome. Over the years it has housed everything from a U.S. Customs office to the company we now know as Citibank. It is currently a banquet hall downstairs.
I was there on Friday to hear European Central Bank President Mario Draghi speak, and it was a sell-out crowd. The main hall can seat 900 people and almost every spot was taken. Of course, given the market’s violent reaction to the Thursday ECB meeting that was to be expected. The senior hedge fund manager sitting next to me said it well: “That was a 6 sigma move… Let’s see what he says today.”
President Draghi did not disappoint. His speech was short, but to the point. The Q&A with Lord Mervyn King and Bob Hormats was lively and seemingly frank. After the event, it was clear which of his statements stood out the most.
When asked by Lord King if the speech, which promised as much action as needed to solve Europe’s current sluggish inflation, was a response to the prior day’s dramatic rally in the euro Draghi said, “Not really. (Long Pause…) Yes, of course.” It was as close as you’ll ever hear a central banker admit that market prices directly inform both policy and the nuanced communication from their institutions. You could feel the room let out a long breath of stressed anxiety, relieved.
Beyond that one statement, however, there were other important messages in Draghi’s talk. And even if the themes are familiar, part of tracking central bankers and their policies is to come to each interaction with somewhat of a fresh mind. What do they choose to highlight? What do they repeat, and what seemingly obvious thoughts get special attention?
For example, the top of President Draghi’s speech focused on commodity deflation and its interaction with “Core” price levels. While he nodded to the standard economic playbook and said the recent supply shock in crude oil and commensurate price declines shouldn’t alter inflation in the “Medium term”, he did highlight where this orthodoxy might be wrong. Simply put, if there are successions of supply shocks that repeatedly reduce commodity prices, then consumers may well reduce inflation expectations.
This point is especially relevant to Eurozone monetary policy for two reasons. The first is that economic growth there is still so low that declining crude prices could well push down inflation expectations more than in, say, the United States, where growth rates are higher. The second is that, unlike the Federal Reserve, the ECB’s only mandate is keep inflation around 2%. Yes, wage inflation – a function of unemployment rates – does play a role in the ECB’s thinking. But unlike the Fed it must prioritize price levels, and the current volatility in oil prices is clearly a front-burner challenge for the ECB.
The other notable item from President Draghi’s talk and the discussion afterward was his repeated use of the word “Calibration” in various forms. It is a word for which he has a distinct fondness, as it portrays monetary policy in the same vernacular as scientific instrumentation. The Federal Reserve has a similar, if less elegant, characterization for its policies: “Data dependent”.
In the context of Friday’s speech, “Calibration” seemed to be a reminder to capital markets that we need to follow the inflation data coming out of Europe every bit as closely as just what we think we see in the tea leaves every time a central banker speaks. President Draghi noted several key inflation statistics, from the prices for services to how many items in the consumer basket were experiencing outright deflation, to explain why Thursday’s ECB meeting had concluded with the smaller-than-expected actions from the central bank. Deflation, he noted, is “Off the table” in Europe. Therefore, the need for large steps had diminished, and markets should have understood that since all the data he cited is public.
Still, Mario Draghi knows he needs the ongoing confidence of the capital market to achieve his long run goals. He does not have many other allies, after all. In the Q&A session with Bob Hormats, he highlighted numerous structural impediments to long run economic growth and therefore price stability in Europe, ranging from tax and labor market policies to the judicial process to reclaim assets in default. He noted that these and other necessary changes need “Social consensus” in order to start the process of reform, meaning politicians will not act on these fronts until the electorate demands them. And there hasn’t been much of that as of yet…
The formal part of the presentation was over just after 1pm, and with markets rallying on President Draghi’s comments I had a chance to consider the events of the day.
First, there was the environment – a lavish hall with near-on 1,000 people in attendance.
Second, the intent focus of capital markets on one individual and his role in setting policy for a continent of 330 million people.
Lastly, his relative isolation from the electoral process – something shared by all central bankers in the developed world – but the need to work within a democratic framework to maintain power. For all practical purposes, that means keeping capital markets informed and generally happy with central bank policies.
That combination of factors has led to the era of the “Rock star” central banker. Paul Volcker and Alan Greenspan were the Elvis and Beatles of this movement – the first to see widespread fame for their efforts. Then came Ben Bernanke, perhaps the Jimi Hendrix or Led Zeppelin of his day, taking existing tools and pushing them in new, previously unconsidered, directions. Now, we have Janet Yellen and Mario Draghi, whose legacies are as yet undefined. They may end up like the next generation of rock stars from the 1970s – something like Bruce Springsteen, with a deep focus on common people in his music. Or, they could be the Bee Gees, who focused simply on commercial success. Only time will tell.
