A relative calm and pacification is permeating global markets this morning due in large part to the fact that many important financial hubs are out on holiday; including Australia, France, and Germany. However, that serenity could be upended rather quickly despite the limited releases of data the rest of the week as the ripples from last week’s data splash continues to disperse.
An example of the current laissez-faire attitude of markets currently is the release of Canadian Housing Starts this morning which returned its best result of the year and represents the second straight positive reading for Canadian data; the first being the 25.8k increase in Employment Change on Friday. In response, the USD/CAD moved all of 10 pips in the next couple hours. Granted the USD/CAD isn’t generally the model of volatility, but c’mon man! Please excuse me while I go take a nap.
Meanwhile, the financial world continues to come to grips with the ever broadening policy of the European Central Bank and its figurehead, Mario Draghi. While Draghi intimated last month that the ECB was “ready to act” at the next policy meeting, many skeptics of the bank felt they would under deliver on that promise; yeah…no so much. Draghi essentially threw everything he had at the market outside of Quantitative Easing by not only cutting the deposit rate to negative, but also introducing a new Long Term Refinancing Operations.
While the EUR/USD initially fell on the announcement of the ECB’s new initiative, it quickly rebounded back to and beyond the starting point near 1.36, and continues to hover near that level as I go to press this morning. Perhaps more importantly, the ECB’s actions have helped further depress the cost of debt for the periphery of the European Union; most notably, Spain.
As you can see from the chart below (Figure 1), Spanish 10 year yields have fallen below 2.6%, a significant value considering US 10 year yields are currently trading above that level. So is Spain a safer place than the US for investors to put their money? Not a chance.
One of the counter effects of the ECB’s recent actions, a term I’ll classify as “Draghinomics”, is that banks will now have to pay for the privilege of keeping reserves at the ECB; a privilege they are likely to refuse. In addition, the LTRO programs offer them loans at REALLY low rates, creating even more capital to disperse. So where do all those excess funds go? At least some of it goes to the relative safety of long-term debt of EU member nations, which is assumed to be protected by Draghi’s insistence a couple years ago that the ECB would do “whatever it takes” to prevent the euro from failing.
The feedback loop that Draghinomics has created has worked so far, but investors do have reason for concern. Remember, artificially low borrowing rates for the periphery of the EU is what created the euro crisis to begin with as debt to GDP ratios climbed exorbitantly and finally reached a tipping point. At this point, Spain is in no place of envy with their economy as the unemployment rate has hovered near 26% since the first quarter of 2013. While Spain is nowhere near Greek levels of debt serfdom, the combination of low rates and a lackluster economy could push it in to crisis territory quickly thereby creating a whole new euro crisis.
While many have foreseen the collapse of the euro for years, only to eat crow as Draghinomics keeps the vessel afloat on the back of promises and sticky tape, they may end up being right after all; just a little later than anticipated.
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