April 4, 2014

Global Macro 360 - Daily Note - ECB chickens out!

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Here is an extract from today’s Global Macro 360 Daily Note. To read the full content click here to sign up for a One Week Free Trial.

ECB chicken

Summary

  • Eurozone: Draghi takes aim with his bazooka
  • United States: Rebound in the service sector as we wait for the March employment report
  • Russian: Economic data continues to weaken
  • United Kingdom: UK business sentiment slows in March
  • Turkey: Inflation pressures intensify in March

Good morning.

The world is a strange place. The Eurozone is about to embark on QE (which is borrowing more for less) in order to prevent the peripheral countries from defaulting, yet Greece, the country that orchestrated the largest sovereign default in history, will this morning be upgraded by the rating agencies!

This event proves the basic notion that the way to fix a country’s balance sheet that has too much debt is with less debt not more debt. If you get to less debt by defaulting, the markets will eventually forgive you and come back and buy your outstanding IOUs.

And speaking of buying IOUs, we see that the market thinks Spanish IOUs are a better bet than American IOUs. For the first time in years, Spanish 5 year notes are trading below American.  For the trader, this is inconceivable. However this is where the trader/strategist and the economist part company and all macro investing is in some way a battle between the trader and the economist as to how best to read the macro environment. For the trader, the idea that the Spanish government is a better bet than the American government makes no sense.

In contrast, for the economist, the demand for money in Spain rather than the risk profile of the Spanish state is driving the fall in Spanish yields. The demand for money has collapsed in Spain, a function of deleveraging and the liquidity trap which I spoke about last week. As the rate of interest is only the price of money, when the demand for money falls, so too does the price.

This morning, with the ECB committed to buying dodgy assets issued by the periphery, the risk premium on these assets falls because we have a buyer of last resort in the guise of the ECB. Therefore, the only factor driving the rate of interest in Spain is the demand for funds, which has collapsed in the private sector. In addition, with the State committed to some sort of austerity, the government won’t be big borrowers in the years to come, so rates are zero bound in the periphery.

I know this doesn’t sound right to the trader but sometimes the trader should listen, not all the time but sometimes, to the economist.

One added implication of this fall in European yields is that the Euro will have to rise to make Spanish assets attractive relative to American assets, but this won’t happen, so the ECB’s QE move has to be positive for the dollar too.

Let’s have a look at what the ECB said yesterday and what does it mean for you.

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