3rd August 2012
There is a saying which talks of the morning after the night before which for ECB President Mario Draghi can now be converted to the morning following the afternoon before. The reason for this is that he had raised the stakes for yesterdays ECB meeting with his speech from last week which I discussed on Tuesday:
"on Thursday the governing council of the European Central Bank meets and we will see if they are minded to back up what has been said."
It turned out that they were not minded to back it up. Instead it was as if Mario Draghi had been teleported out of the room and replaced by Sir Humphrey Appleby of Yes Minister fame as important decision after important decision was given to ECB committees. This was how Sir Humphrey kicked uncomfortable matters into the long grass as by the time such committee's report the debate has usually moved on.
It is rare to see a head of a central bank openly mocked and indeed laughed at rather than with but this is what took place. And in some ways even more serious was the way that Senor Draghi was vague over issues such as the difference between the ECB's Securities Markets Programme and full bore Quantitative Easing. He gave the impression he did not understand the difference which if you are a Euro area taxpayer must have been rather disturbing.
As I watched the Draghi debacle I have to confess I was trying to figure out an exact date when central bankers morphed into politician like behaviour. Hype and bombast has overtaken facts and detail. The catch is that when they move into the arena of misrepresentation they debase their reputation and should a bank fail what is needed is a central banker with credibility and reputation.
What did Mario Draghi actually announce?
Senor Draghi did what many do when they have nothing really to say he gave us quite a bit of detail on some subjects. If we look back much of what he had to say was something of a deja vu moment as he was repeating his predecessor Jean Claude Trichet.
So if we nail down where the ECB stands we see this. A country in trouble needs to call for help from the European Financial Stability Facility before any help in terms of bond buying will come from either the EFSF or the ECB. There are two immediate issues here of which the first is national pride. In other words a country is likely to delay asking for help until it is actually forced too. And the delay in acting would be exacerbated by the slow way in which the EFSF itself would act. I have discussed this in detail in past articles but under its rules I would expect the EFSF to take between a fortnight and a month to respond by buying the government bonds of whoever is in trouble.
The market response
We saw an unsurprising response which was that Italian and Spanish ten-year bond yields rose as investors sold them. Spanish bonds has been rising earlier in the day at the ten-year yield had fallen to 6.61% but falls were heavy once Draghi's words were digested and the yield surged to close at 7.16%.
However not every yield rose as Senor Draghi pointed out that future ECB intervention would come at the shorter end of the maturity spectrum. So Spanish two-year bonds rallied and have pushed higher again today with the yield falling to 4.41%.
There are a lot of implications from this but to my mind there is a danger in a steepening yield curve where shorter dated yields fall and longer dated yields rise. It is simply that Spain will be tempted to fund herself at the shorter end which will mean that the problem will come around ever more quickly. Peddling faster to stand still….
The Euro did fall heavily from pre meeting hopes of 1.24 versus the US dollar to below 1.22 but with the latest US employment/unemployment numbers due out this afternoon Draghi's debacle may already have moved to the background.
Probability and market interference
If we consider what happened in the Spanish bond market yesterday we see that holders of short dated paper were standing in the sun but holders of longer dated paper were in the rain. This happened because of the words of one man the ECB President and this happens ever more often because central banks are ever more involved in the world economy. If anyone else did this it would be called market rigging and creating a false market.
But if we return to probability it poses challenges as a range of them comes down to two, either the ECB will or it will not. At the extreme we drop from an infinite choice to a binary one. And at the same time we see with algorithmic trading extreme speed and an ability to calculate anything just in time for the choice to narrow to 2 options! I know it is wrong to give computers personalities but I cannot help but wonder if the blow up at Knight Capital this week was due to their computers taking on the personality of Marvin the Paranoid Android from The Hitchhikers Guide To The Galaxy:
"Brain like a planet and all they give me are two choices…."
Either way they moved from market makers to anti market makers as they bought at the offer and sold at the bid and again and again.
Meanwhile in the real economy
If we move from promises of market manipulation to the real economy in the Euro area we have already seen today that the problems are continuing. It looks as though July carried on where June left off if the purchasing managers index is any guide (50 is the benchmark here):
"Final Eurozone Composite Output Index: 46.5 (Flash 46.4, June 46.4)"
The figures in the second quarter led the compilers Markit to estimate that they were equivalent to a 0.6% fall in Euro area Gross Domestic Product. So it looks as though the first part of the third quarter has continued this and as you can see below the immediate future does not look bright:
"The level of incoming new work contracted to the greatest degree since June 2009,"
We also saw data released on the Spanish service sector where we saw a PMI reading of 43.7 and the Italian equivalent which registered an even worse 43.0. These are the sort of numbers we have become used to in Greece and it is clear that she is no longer
Again as we look forward we see that the immediate future looks grim too.
"new business fell at an accelerated pace. Another negative development was on the employment front as the rate of job cuts accelerated,"
"Conditions across Italy's service sector took a turn for the worse in July, as incoming new business fell at the fastest rate since March 2009."
So we see that both nations seem to be taking a turn for the worse. Unfortunately this is from a weak base particularly if we consider the existing high level of Spanish unemployment.
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