Tower Private Advisors
‘running out of time on this Friday afternoon, but the Europeans moved closer to a solution this weeek, and you need to know about it.
The market had known that the European Central Bank (ECB) was to be meeting yesterday, and high hopes had been placed on the ECB chief, Mario Draghi. He did not disappoint, as evidenced by market action yesterday. In short, the ECB addressed the issue of liquidity by announcing a plan to buy sovereign bonds to keep interest rates low. The central bank will buy the debt of nations whose interest rates are rising–the usual suspects of Spain, Italy, et al–and that buying will push interest rates down for that country. Even the idea of Mr. Draghi pursuing this option has pushed interest rates down in the aforementioned countries, as can be seen below.
Here are the salient points of the deal.
- No limit to purchases was mentioned, which means that the ECB will buy bonds until rates are below danger levels. The open-ended nature of the deal should serve to kneecap any bond vigilantes.
- The purchases will be sterilized, which means the ECB will offset purchases with bond sales from its portfolio. In turn, that means the ECB’s balance sheet, which had grown by 64% since March 2011, won’t expand any further, and the ECB can avoid charges of printing money.
- The countries whose debt the ECB buys will, by definition, be the countries with the worst fiscal pictures, and they’ll have to comply with “long-term fiscal solvency,” as BCA Research put it in a report today.
Notice the difference and similarity between the ECB and Fed actions. Both are intent on keeping interest rates low (similarity). The ECB, however, is trying to keep rates low so that overleveraged countries can continue to fund themselves by issuing debt. On the other hand, the Federal Reserve is keeping rates low to support the housing market and to push investors into riskier assets to affect the ec0nomy through the wealth effect (“gee, my 401(k) is bigger; I think I’ll buy a new car.”) The U.S. is trying to stimulate the economy; the ECB is trying to buy time for overleveraged countries.
Think of it this way. In the U.S., we experienced our Lehman Moment, when our markets and economy nearly siezed up entirely. Almost exactly four years later we’re still trying to jump start–sticking with the engine metaphor, we’re spraying ether into the carburetor–the economy. What the ECB is trying to do is to help all of Europe avoid its Lehman Moment (ours involved a company; theirs would have involved acountry.)
Some have called what the ECB did kicking the can down the road, but it really didn’t. It addressed a problem with probably the best means it had. This should keep interest rates low in those troubled countries–Greece, by virtue of item #3 in the deal above, may [is likely to] still go under, but market participants will have had ample opportunity to prepare themselves for it–thus, helping them avoid an illiquidity problem; i.e. their Lehman Moment.
What does make it seem like can kicking is that the underlying problems of the troubled countries have not been addressed. Spain and others are still in recession–as may be all of Europe; German, the strongest, biggest European country is struggling to avoid recession. Spain and the others are still hugely overleveraged. Those problems can only be fixed by growing economies. I’m guessing that about four years from now, the ECB will be seeking ways to stimulate its economies, having avoided its Lehman Moment.
That was the biggest reason for markets to rally this week.
Today might have been a heyday for conspiracy theorists, what with the big Nonfarm Payrolls Report coming out the same week of the Democratic Convention. Alas, it wasn’t to be, as the number of jobs created was just 96,000, well below the anticipated 130,000 and the prior month’s 163,000. So put that in your Trilateral Commission pipe and smoke it. There was a silver lining in the cloud, and that was in the form of the–headline-making–Unemployment Rate, which fell to 8.1% from 8.3%. It didn’t, however, come down for the right reasons. Indeed, while the number of unemployed folks fell by 250,000, the Labor Force shrank by 368,000. Those folks said, in effect, forget it, and in so doing they removed themselves from the counted.
It’s easier to understand from the employment side of the equation. The number of employed folks fell by 119,000, from 142,220,000 to 142,101,000…bad, right? But the labor force fell by 368,000, from 155,013,000 to 154,645,000. That’s bad, too. In this case, though, it seems that two wrongs make a right, because when you divide the numerator (142,101,000) by the denominator (154,645,000) you find the Employment Rate has risen, from 91.75% to 91.89%. Remember that while two wrongs don’t make a right, two Wrights make an airplane.
In short, while the unemployment rate will be the headline, thus satisfying the conspiracy folks, it is not good. It fell because the labor force fell by more than the number of people employed.
Curiously, perhaps, that forces Ben Bernanke into the same position ECB chief Mario Draghi found himself a few days ago, with a lot riding on what he said. As a result of our soggy jobs report, investors are pushing up their expectations for Quantitative Easing round #3, some to as soon as next week. We have one research service that calls us if it sees its name here, so it’ll remain unnamed, but its report on this subject included the following in red bold type: “the odds are very high the Fed will launch QE3 next week,” and Credit Suisse said, “the poor August jobs figures cement our view that the FOMC will vote for more policy accommodation at the September 13 meeting.”
While each round of quantitative easing has produced less spectacular results–otherwise known as diminishing returns–its like crack cocaine for an addict…a quick hit gets you by until the next.
Judging by the action in gold, that market is anticipating quantitative easing by whatever name. The chart below features gold in terms of Euros and in dollars. Both confirm the other.