Draghi is cheap talking, but could take action against low inflation

Outlook

Bloomberg reports that many analysts think Draghi is engaging in “cheap talk” when threatening QE and other euro-weakening measures. At the same time, the Bloomberg strategist survey calls for the euro to fall to $1.36 by June 30 and $1.30 by year-end, but this is predicated on the Fed continuing tapering on a strongish US economy, not a reaction against easing by the ECB. Well, maybe, but it’s a rare occasion when the dollar goes up because the US economy is strong.

We agree that Draghi is blowing hot air, actions speak louder than words, and talk is cheap—but that doesn’t mean Draghi does not fully intend to take action if warranted. Draghi is no blowhard. What warrants action? Hard evidence that declines in inflation are continuing. Cutting under 0.25% is anathema and not taken lightly, and we worry that comments that a rate cut comes first are not the way it will play out. We’d guess negative interest rates come before a rate cut. After negative rates, the rate cut, and after that. QE. If the ECB acts with something at every meeting, the earliest we get the cut is June and the earliest we get any QE is July.

The WSJ today has a cautionary tale in the QE saga that we don’t even begin to understand. Yesterday Japan issued a new 10-year note and it didn’t trade at all. “If the 10-year JGB goes a full 24 hours without being traded, it will be the first time since Dec. 26, 2000, according to the Japan Bond Trading Co., which publishes rates. That seems likely, since most investors close their books at 3 p.m. Tokyo time.” The BoJ is buying nearly everything--¥7 trillion per month and about 70% of all new issuance. “At the end of March, the BOJ owned about 33% of the current No. 333 10-year bond, the one that didn’t trade Monday…. The 10-year JGB yield was at 0.605% when it last traded Friday.”

What can this mean? Some say that when conditions change, we could see a violent move in bond yields. But we don’t know the trigger. Clearly the bond gang in Japan doesn’t see inflation on the horizon. And Europe is not Japan. On the public debt issuance front, it’s the exact opposite. But you have to admit, when a government issues a note and it’s doesn’t trade at all, it’s really creepy.

Today the US calendar includes chain store retail sales, Redbook, the Empire State manufacturing survey, the NAHB housing market index, and TICS. TICS will tell us, maybe, whether China is diversifying away from dollars and how much short-term capital flowed in during Feb, as things started heating up in tapering and in the Ukraine.

We are hesitant to suggest that conditions in the world today justify a safe haven flow into the dollar. But a slowdown in China has a lot of people roiled up, even though confidence in the Chinese government’s resolve and competence is still pretty good. But we have an abundance of stories about ghost cities, loans collateralized (or not) with copper inventories, and a whole lot of guessing about municipal and state financing, not to mention the quality of the credit market. China should take a leaf out of Japan’s book and aim for high quality in manufactured products as well as in data. Reliable, credible data would go a long way toward calming fears and restraining capital outflow, presumably a major fear in Beijing.

As for the Ukraine, there is no favorable outcome. Depreciation, wildly high yields, recession and general misery are in the cards, and that’s if Russia were to withdraw entirely. Will there be a shooting war? Probably. Will the US or NATO get involved with boots on the ground? Probably.

We are on the cusp of the markets feeling like their backs are against the wall. This is always dollar-favorable. But it’s a lousy reason and lacks reliability and sustainability. At this point ,the only currency we like is the AUD, and even there the RBA is an undermining factor.

Note 1 to Readers: Publisher 1997 finally gave up the ghost. Microsoft really will not let you use old software on a new operating system, the bums. We have been trying to get our chart packages over to Publisher 2013 but Microsoft doesn’t make it easy. After probably 50 hours, we may have a grip on how to do it. Today’s chart package is awful and it’s incomplete, but it’s not nothing. More tomorrow, we hope. If anyone has comments on what you want by way of charts, now is the time to write.

Note 2 to Readers: Friday is a holiday in some countries (and Monday, London is closed). We will not publish a morning report on Friday.