The European Central Bank met this morning, and the expectation going in was that they need to do something drastic. In the past, ECB President Mario Draghi said they would do anything it takes, but ultimately disappointed. This time around, analysts expected a cut in interest rates, which were already negative, and an increase in their asset purchases or QE.
Well, the ECB delivered.
On top of cutting the rate by 10 basis points as expected, the ECB increased their asset purchases by 20 billion euros, which was a lot more than expected. And now, those purchases will include non-bank corporate debt. There are only so many government bonds they can buy, so why not try something else!? The ECB also surprised by cutting the interest rate on their main refinancing operation to that all-important level of 0%.
Overall, this policy will help drive down rates on bonds, savings, and mortgages. Supposedly this will encourage savers to spend and stimulate the economy, and this stimulation will also supposedly encourage banks to lend.
But what if it doesn’t?
This negative rate policy already failed in Japan. The Bank of Japan (BoJ) tried going negative but quickly backed off when it back-fired. The goal was to weaken their currency and to get stocks to go higher.
Well, the opposite happened. The currency got stronger and even forced us out of a bearish trade on the yen in Boom & Bust that we’d been building the past couple years. (We collected nearly 100% on this trade and there’s a chance we’ll get into it again at some point when all this dies down a bit.)
Clearly, here is a central bank that will do anything to stimulate their economy. But it’s not working. And just today, we’re already starting to see the same thing happen in Europe.
Following the policy announcement the euro traded lower and stocks were up. As the day has gone on, that’s reversed. Stocks have turned lower and the euro’s up again. Back where they started!
This all suggests that investors are starting to catch on that central banks don’t have any bullets left to fire. Really, it’s not a matter of “if” things get worse, but “when.”
If this trend into negative rates continues, here’s what I think will likely happen.
I suspect many savers will opt out and just hoard cash if their banks charge them to hold a deposit. That, or they’ll sit tight and take a slight loss on their savings. But I doubt this will encourage more borrowing or spending. These policy changes reek of desperation and don’t exactly make people want to go out and spend!
All of this stimulus or central bank action is really just a way to devalue their currency. Driving rates lower or into negative territory isn’t a proven way to stimulate spending or lending, but it definitely devalues currencies.
When that happens, it makes it cheaper for stronger currencies to purchase goods and services from the weaker currency country. Conversely, it makes it harder for the stronger currencies to export, and that’s what we’ve seen here in the U.S. The initial reaction to this morning’s ECB action was to weaken the euro and strengthen the U.S. dollar.
All of this begs the question, what will the Fed do?
Janet Yellen, Chair, Federal Reserve Bank of the U.S., will be meeting with her fellow members of the FOMC next week to decide if a change in monetary policy is warranted.
The last action was at their December 2015 meeting when they hiked the federal funds rate by 0.25%. The Fed has no pressure to hike rates next week as the general consensus across the marketplace is they’re going to wait until June, anyway.
But, whether the Fed is really acting on economic data, or reacting to the financial markets and international central bank policy, it doesn’t matter. Economic data isn’t stellar, financial markets look shaky at best, and central banks are going the other way!
Besides, why would the Fed hike rates again? That would only strengthen the U.S. dollar, put more pressure on earnings, risk jobs, help lower the price of oil and curtail capital investment. No thanks.
The Fed has been leading us to believe that our economy has improved enough to continue the path of rate hikes. They want a growing economy, full employment and wage growth along with a stable financial market.
The problem is that any more hikes will further strengthen the dollar and hinder economic progress, especially when foreign central banks are loosening monetary policy and devaluing their currencies.
This is what happens when these arrogant and smug central bankers – who have never run a business, managed other people’s money and have spent their careers in academia or government – are trying to guide entire economies!
However, at least one Fed official appears to be changing his outlooks. The New York Fed President, William Dudley, made comments a week ago that fueled a stock rally. He is lowering his economic outlook and appears to be against another hike in the near future.
Another surprise comment by the Fed could trigger a trade alert in my Treasury Profits Accelerator. Surprises often times cause overreactions in asset prices, especially in Treasury bonds. Earlier this week we made a 69% profit in a single day! You can see how we do it here.
Editor, Treasury Profits Accelerator
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