Saturday, March 10, 2012

All of Europe's a stage...

Bloomberg had a good summary of Mario Draghi's comments from the ECB press conference on March 8, 2012 in an article entitled Draghi Lays Groundwork for ECB Stimulus Exit as Inflation Takes Spotlight [emphasis added]:
Declaring that the environment “has improved enormously” and there are “many signs of returning confidence in the euro,” Draghi yesterday turned the spotlight on “upside risks” to inflation, which is now forecast to remain above the ECB’s 2 percent limit this year. That suggests policy makers don’t plan to cut rates further or add to their 1 trillion euros ($1.32 trillion) of long-term loans to banks, economists said.... 
The Frankfurt-based ECB must “go back to normal, classical central bank policy,” he said.

Draghi's message to the politicians was, "We've done our part, it's time for you to do yours" as he hinted that not only would there be no further LTROs, but the next ECB step would be some form of tightening.

How much of that is to be believed?

The Theatre in Europe
I wrote about how Draghi revealed the Grand Plan in a WSJ interview, which consisted of:
  • "Good" government austerity, in the form of lower taxes and less spending; and
  • Structural reform, in the form of the elimination of the European social model.
For the that Grand Plan to work, you need a compliant central bank to print money so that the system doesn't seize up. So how much of what Draghi said is bluster and how much is real?

I interpret what Draghi said as being totally consistent with the message of: We will print more money if necessary, but on the condition that the politicians move forward with the Grand Plan's reforms. Otherwise, be prepared for tightening.

It seems to me that even the Germans are on board with the Grand Plan. Despite the German cultural aversion to money printing, notice that there wasn't a single complaint from either the Bundesbank or any of the German hardliners about LTRO, which has been documented to enormously expand the ECB balance sheet? Instead, we got a letter from Weidmann of the Bundesbank complaining about a technical point with LTRO, i.e. the quality of collateral.

Is this complaint about collateral quality just theatre? If so, then is Draghi's comment about going "back to normal, classical central bank policy" also part of that theatre?

I interpret all these statements as part of the "show" that's been going on in Europe as the elites proceed with the Grand Plan. The German complaint is part of the chorus of doubt that accompanies the main show and so is the ECB response, but they are not likely to be significant. No doubt, the ECB has the power to derail everything should any government step out of line, but my guess is that everyone pretty much knows the score. If needed, don't be surprised if the ECB stepped up with further LTRO or LTRO-like programs. Recall that I wrote that analysis reveals that the European banking systems may need up to four LTROs in order to fund their liquidity needs to 2013.

I recognize that the ECB doesn't want the banks to get addicted to LTRO, but do you expect the Draghi to allow European banks to fail as long as the Grand Plan is proceeding smoothly?

Expect more drama, but also expect a happy ending as long as all the players know their lines.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

No comments: