This year has been a year of surprises as conventional wisdom-based forecasts have proven to be like oral agreements: not worth the paper on which they are written. The coming year promises to bring more confusion and volatility as the markets are preparing for the U.S. to be a Trumpian utopia of wealth creation. I caution against blindly accepting this narrative for it will not be a U.S.-centric year. Attention will turn to Europe as the political cycle brings elections in the main players. France and Germany are the EU and the rest just the trimmings (so stated Charles De Gaulle). The EU is fraught with problems, so the more uncertainty raises the profile of the ECB President Mario Draghi. Senator Charles Schumer once said to Fed Chair Ben Bernanke, “You are the only game in town.” Well, an ECB with a printing press and no political accountability provides a central bank on steroids. Mario Draghi perceives himself as the savior of the EU project so expect him to be hyperactive in response to any major political changes in France. Greece, Italy and Spain still remain an economic issue so the entire EU financial system will be subject to paroxysms within its debt and equity markets.
Today, FAST FT had an article titled, “ECB Should Not Be Afraid to Raise Interest Rates, Says Bundesbank Chief.” Jens Weidmann has been a dissenter on the continued hyper-active QE program of the ECB and certainly one opposed to the negative interest regime. Weidmann said, “… the real litmus test for the ECB would come when ‘it becomes clear that monetary policy must be normalized with a view to price developments.’” Weidmann seems to be setting the agenda for the Bundesbank pushing back against the unmitigated authority of President Draghi. When citizens in Germany tried to block some ECB policies because they violated German law, the high German Court allowed the European Court of Justice to resolve the question. The EU High Court sided with Draghi and the ECB because the need for the European Union to survive made the Outright Monetary Transactions (OMT) lawful, basically delivering President Draghi the power to do “whatever it takes” without taboos. The issue of ECB bond purchases will continue to be challenged and may well be the main issue in the coming German election.
The conventional wisdom is that immigration will be a paramount issue for Chancellor Merkel but I opine that the ECB will be more important as the question I continually pose is: “Who guarantees the ECB?” Every buyer of EU sovereign bonds –Italian, French, Spanish, Portuguese, Greece–believes it is the German credit card that provides collateral for the entire EU. Otherwise, how else could Italian 10-year notes be yielding 70 basis points less than the U.S. In terms of two-year yields the differential is 135 basis points. So understand this: Italy, a country with a debt-to-GDP ratio of 135%, without control of its own currency and in the throes of a banking crisis, can borrow money for much lower rates than the United States. Everything falls upon the Bavarian Burghers to sustain the credibility of the ECB. Again, Weidmann seems to have taken a very public stance on the ECB’S QE program. The past year was a “long strange trip” and I wonder if 2017 will be a financial “box of rain.”
Wishing all my readers a wonderful holiday season. May it be a meaningful holiday time whether you’re celebrating Christmas, Hanukkah, Kwanzaa or anything else that brings joy and meaning to your life. All the best, Yra.