Funky money’s here - QE infinity!

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As predicted on Tuesday.

As predicted, the ECB has cut its deposit rate from -0.4% to -0.5% and has also announced a restart to QE and a new tiering system (with details to be released later).

QE6+NIR (negative interest rates) will commence in Europe in November at a rate of €20 billion per month, for as long as necessary.

Crikey, that does sound like a long time - and we’ve already had 10 years of it, other than for a short reprieve over the past 9 or so months.

It’s now officially a case of you can check out any time you like, but you can never leave.

Tiering.

So far we know that a two-tier system for reserve remuneration will be introduced, in which part of banks’ holdings of excess liquidity will be exempt from the negative deposit facility rate.

On the face of it, that’s a good side-car to have as it should limit the extent to which the banking system as a whole would have had to pass on negative rates to their own depositors, potentially leading to withdrawals and cash hoarding.

Central bank tools have their limits.

Yes, they do.

On Tuesday I noted that a full funk Draghi would mean:

  1. Deeper negative interest rates.

  2. Tiering, perhaps like the Japanese model where some bank current accounts will have a positive interest rate and others have a zero rate or a negative rate.

  3. Restarting bond purchases.

  4. Potentially renewed calls for a ‘fiscal instrument’ or guarantee which can coexist with the ‘no bail-out’ rules.

Well, point 4 was nor reprised, but he was pretty much full funk Draghi when he added that there was “unanimity that fiscal policy should become the main instrument".

Presumably he was talking about Germany and France?

A few extra squirts from the ECB smoke machine.

But, it was more than the full funk I was expecting.

On a much darker note, the ECB has predicted lower GDP growth for FY20 (1.0%, a massive drop from the 1.4% forecast in June) and inflation (1.2% down from 1.4% in June).

QE+NIR will stay in force at least until inflation nears the 2% level - so it nearly has to double from here.

That’s a fair bit of dried ice to blow over the crowd, and it’s these last two aspects of his release which are bad signs and portents for the global economy.

That’s pretty much what full funk Mario Draghi looks like.

Currency war, game on mole, again.

As for the currency war, and in response to Donald Trump’s tweet, Mario Draghi said:

"We don't target exchange rates, period."

Still, the Euro was down after the announcement and continues to get belted as I write.

Eurozone bonds have rallied and yields have dropped. Here’s a quick comparison from the Financial Times:

  • Germany, -0.638%

  • France, -0.37%

  • Spain, 0.18%

  • Italy, 0.819%

  • UK, 0.58%

  • US, 1.687%

    From a purely financial perspective, these are the risk free rates which analysts are pumping into their CAPM and discount rate calculations.

What next?

Prior to the meeting, Turkey cut interest rates.

The Swiss and Japanese centrals will be meeting soon. Switzerland might be looking at lower rates.

The UK has to grapple with Brexit when thinking about its interest rate policy and a hard Brexit might mean more QE in the UK.

Gold and US Tech stocks are up.

Global economy tracking stocks Caterpillar and FedX are both down, as is oil.

Fed Reserve Chair Jerome Powell will most likely cop it from the President if the US Fed does not lower interest rates at the next meeting.

While the answer according to outgoing Mario Draghi is ‘fiscal policy’, it may not make that much of a difference if the US and China continue their war of blunt instruments.

In other words, now would be a good time to see an end to the trade war and a reversal of the tariff increases - back to a pre-Trump 5%.

Stay tuned.

Mike.


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