ECB President has New York temper tantrum as Board blocks major new stimulus

Economic growth


Yellen Dec15“There is no doubt that if we had to intensify the use of our instruments to ensure we achieve our price stability mandate, then we would.”  (Mario Draghi, New York, Friday)

Pity poor Mario Draghi, President of the European Central Bank (ECB).  He is used to the adulation of markets – and adores his nickname of “Super Mario”.  So we can only imagine how crushed he must have felt by the market collapse that greeted his big new policy announcement on Thursday.  The yield on the benchmark German 10-year bond rose 45% in a single session – the complete opposite of Draghi’s intention.

What a flight he must have had from Frankfurt to New York that night.  Were markets poised to realise he was “yesterday’s man”?  Even worse, would they start to wonder if monetary policy could really rescue Europe and the global economy?  Could today’s ageing populations mean that the economy was moving in a New Normal direction?

All these thoughts must have played in his head on the long flight.  So unsurprisingly, he decided to go back to the mode that had worked so well in the past – the sudden, and unsupported, comment that the ECB would “do whatever it takes” to rescue the euro.  That had secured him the nickname of “Super Mario” in the first place.  So why shouldn’t he do it again, this time in New York?

His deputy laid the groundwork earlier that morning with CNBC, claiming it was the markets that were at fault in not appreciating the genius of Mr Draghi

The markets got it wrong in forming their expectations,” Mr Constâncio said. “They did indeed have higher expectations than were there and that’s why they reacted like they reacted but that was not our intention.”

Even better was the support of Ray Dalio, who runs what has become the world’s largest hedge fund thanks to the free money policy of the world’s central banks.  He obviously doesn’t want the magic money printing machine to be turned off, so unsurprisingly he blamed “erratic investors”:

“[T]he more the market discounts that Draghi will move inadequately (eg. the more the euro goes up and the stock market goes down) the more that it is likely the ECB will move at an accelerated pace and prove the market wrong,” he wrote: “That is because Draghi and the body of those in the ECB who shape policy with him understand how the economic machine works.”

With support like that, of course the market reversed course on Friday.  But as Reuters reports, Draghi’s plans were blocked by his Executive Board, due to German pressure.  He cannot just do what he likes anymore.  No wonder he had his temper tantrum – Super Mario clearly did not like his cloak of invincibility being blown away.

Questions may also be asked of Janet Yellen, US Federal Reserve chair, after she raises interest rates next week:

  • She published the chart above last week, supposedly showing that all economic theories supported her policies
  • But in fact, the text shows they all use the same DSGE (“Dynamic Stochastic General Equilibrium”) model

And as the Financial Times noted last week before Draghi spoke on Thursday:

“Central banking has become a closed union shop, controlled by a single syndicate, which we can call the DSGE or “the canonical model”.  And yet nobody outside the current or former denizens of central banks, ministries of finance or university economics departments even knows what the model is. Because it does not work, it and its cousin models have little if any forecasting power, and are poor or even deceptive descriptions of how market economies function.  However, you have to know the DSGE to get a professional job in a central bank.

After 6 years of vast stimulus, investors are entitled to expect that economic recovery is assured.  The fact that it is remains uncertain, means that more and more questions will be asked.  And in turn, the closed shop built around the DSGE model itself may also start to be questioned.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 59%
Naphtha Europe, down 53%. “Europe’s naphtha is being absorbed by Asia which has remained its main export outlet for the most part of the fourth quarter”
Benzene Europe, down 56%. “The market is waiting for the outcome of the OPEC meeting.”
PTA China, down 41%. “The buying momentum built up over the past weeks weakened.”
HDPE US export, down 33%. “Export Prices held steady this week, with little buying activity”
¥:$, down 20%
S&P 500 stock market index, up 7%


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