Week End Blog – Draghi does it again!

Draghi does it again! A headline very appropriate for many financial articles and blogs, including this one. At the press conference, following the decision of the Governing Council of the ECB not to change interest rates, Draghi lifted markets by hinting at more QE. At least that’s how investors ‘understand’ it. Draghi has told ECB staff members to examine the current QE program, stating that ‘QE can be adjusted’. This strongly resembles last year’s routine when Draghi ordered his staff to prepare further measures in November. This was then followed by the announcement of quantitative easing in January. Anyway, in yet another demonstration of Draghi’s credibility, the euro plummeted more than 2% against the US dollar.

Interest rates also dived after Draghi’s comments, sending the 2-year German bond yield to a new all-time low of -0.31% (currently -0.32%). A negative yield of -0.20% is not the lower bound, after all. Longer term bond yields also collapsed with the 10-year yield differential between Italy and Germany narrowing to less than 1%. Party like it’s last April?

More QE to fight lowflation, is what the ECB is all about. And, in all honesty, lowflation is abundant. The German PPI fell 2.1% in September, which was more than expected. The number was the latest in a series of lower than expected PPI numbers, indicating deflationary pressures still linger.

Perhaps the seemingly huge amount of comfort Draghi expressed while hinting at more QE has something to do with the graph below. Given the balance sheet growth of other major central banks, like the BoE, the Fed, and certainly the BoJ, the ECB is far behind. From this perspective it has quite some catching up to do.

The global QE race, that has been going on for years, has sorted some crazy effects. Dwarfed by the size of the ECB, the Swiss Central Bank already had to lower its target rate to a -0.75% to ‘protect’ its currency. For some time now the Swiss sovereign yield curve looks pretty ridiculous, and Draghi’s statements indicate things could even get a little crazier.

A quick word on inflation. The ECB’s primary task is to ensure price stability, which is quantified through an inflation level of just below 2%. We have to go back to early 2013 to find such a level. This explains why the ECB is so worked up about inflation. But the graph below adds some perspective. It reminds us that the inflation level is very much dependent on how it’s measured. If the US CPI was calculated in the same way as the Eurozone CPI, things would look even worse in the US. And yet, we perceive lowflation to be a bigger problem for the Eurozone, instead.

Surely, Mr. Draghi has no ulterior motive for increasing the amount of QE. But unintentional positive side effects are, of course, a welcome bonus. The chart below shows that European equities tend to outperform US equities when relative money supply growth is going up in the Eurozone. With more QE on the way, and, equally important, improving lending surveys, European stocks could benefit from an increase of QE.

Thank you, Mr. Draghi, for another wonderful show. Moving over to China, which also managed to impress investors. First, economic growth topped forecasts in Q3, with GDP rising 6.9% YoY. That means the China is still slowing, but less than anticipated. As always, Chinese macro data have to be taken with a grain of salt. The Bloomberg monthly GDP estimate is trailing the reported number for quite some time now. But still, some signs of stabilization are starting to appear.

But just to make sure it means business China, one day after Draghi’s comments, lowered interest rates and the reserve requirement for banks. Suddenly, central banks bazooka’s are all over the place. More stimulus was expected, but Chinese timing remains inimitable. You just never know when they will act. Anyway, as of Saturday the 1-year lending rate is 4.35%.

Lower rates and better than expected GDP growth do not take away China’s debt problem. Quite the contrary! Lowering rates and the reserve requirement ratio will entice companies to take even more debt. But that’s of no concern now, right?

Two to go. Until this week, pessimism about company earnings was growing. The graph below shows that periods in which earnings come down significantly are rare. But they are also very bad for equities, so the ‘earnings-anxiety in markets is understandable. But as Amazon, Google (or Alphabet) and Microsoft neatly demonstrated, the earnings recession has not yet arrived!

Finally, a great chart by Max Roser to end this Week End Blog. Poverty has fallen dramatically over time. So, ‘yes’ there is much more work to do, but we should not deny we have made some serious steps in eliminating poverty.

Thank you for reading the Week End Blog. Enjoy your weekend!




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