Life used to be much simpler when Alan Greenspan was Chairman of the Federal Reserve. Every so often the markets would go into a funk, Greenspan would come out, say a few soothing things or organize a bailout of some sort, and we would all return to our old ways, confident that the markets would soon be back on track again.
Unfortunately, there are no Greenspan-type magicians at the Fed these days. It’s now chockfull of economic policy wonks like current Chair Janet Yellen, Vice Chair William Dudley, and Stanley Fischer, all of whom go out of their way to say things to spook the markets without accomplishing much on the other side. That’s why I do miss Greenspan sometimes, even if his final grade was not so good because the U.S. and the world levered themselves quite significantly during his tenure. In any event, at least the markets were fun.
Now it seems as if European Central Bank (ECB) president Mario Draghi is looking to fill the Greenspan magic vacuum. Yesterday, on cue, in the midst of the worst start to a year in history for the financial markets, Draghi came out and foretold of an upcoming ECB easing in March. Risk markets took it to heart, as they have every time Draghi has made some pronouncement. The result is general relief all around in virtually all markets: Equities are rallying, the Japanese yen is rising, the euro is declining, and oil is rallying.
Conjuring Up Additional ECB Rate Cuts
In his role as the new magician of the financial markets, Draghi faces a few challenges. As it became clear in November and December, left to his own devices, Draghi would have eased European monetary policy even more aggressively than he did. Unfortunately, he had trouble carrying the rest of the ECB governing council.
So it is worth asking whether he is speaking for the full ECB council this time around. While we won’t know for sure until March, I feel comfortable that Draghi is speaking for the council. We should see a bigger ECB easing move – including a 10 basis point rate cut and a more front-loaded asset purchase program – all supported by near- and medium-term forecasts that inflation will remain sub-par.
These moves, in turn, are going to be positive for European economies. On the other hand, if Draghi flubs again, as he did in December, his career as a Greenspan wannabe is going to be short-lived.
A World Starved for Liquidity and Dollars
All kidding aside, I firmly believe that Draghi is trying to do the right thing. Interest rates may be low, but the world is very much starved for liquidity. And that lack of liquidity is being created by the Fed’s policy tightening moves in the face of a collapse in global trade that has substantially reduced the savings of the emerging markets (EM) world.
As the world adjusts to these new lower levels of global trade and EM savings, global central banks must keep money really easy to provide much needed liquidity. While ECB and Bank of Japan easing policies help in that regard, what matters more at the end of the day is what the Fed does because most global trade remains denominated in dollars.
With the U.S. current account deficit declining, the world remains starved for dollars and the Fed is the only one that can satisfy that hunger. I have no doubt that at some point in the not too distant future the Fed will get off the tightening path and the bull market will resume.
Until then, I am going to watch and enjoy Mario the Magician’s market related magic tricks.
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