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Monday, 18 December 2017

The art of speaking without saying anything

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Today ECB President Mario Draghi is slated to speak in Lindau, a particularly quiet and gentle resort on Lake Constance, at the Meeting on Economic Sciences. The conference prides itself for attracting 17 Nobel laureates and 350 young economists from 66 countries who are expected to hang on their every word. Those who remember the failure of Long Term Capital Management with its bevy of Nobel Prize winners might wonder how economics can still call itself a science rather an a dark art - but this is all happening in Germany where there is still a belief that the bigger an individual’s academic title, the higher the probability of said person’s pronouncements being correct.

Nobody seems to know what St Mario is going to say. The consensus is that he will try to avoid another “Sintra moment” in which he scared the living daylights out of financial markets by suggesting that the time had come to start tightening up the ludicrously loose monetary policy which the ECB has been pursuing despite the visible recovery of the eurozone economy. With him speaking both today in Lindau and on Friday in Jackson Hole, dedicated ECB watchers see all their Christmases coming at once. That said, if one drew a graph which tracked what Draghi has said and another one which followed what he has actually done, liquidity programmes aside, I suspect they would not display too many cross-over points.

Spot euro was at US$1.04 when the FOMC tightened rates from 0.25% to 0.50% on December 14. There have been two further 25bp Fed tightening moves - in March and June - and the euro has nevertheless rallied by around 13% to its current standing around US$1.17-$1.18. The last thing Draghi needs now is markets anticipating an imminent policy normalisation move by the ECB and concomitant euro buying. It will therefore surely be incumbent on the ECB supremo to talk lots and to say nothing. But in order to justify their salaries, economists and strategists will without a doubt be reading all manner of intentions into the verbal vacuum.

I fear central bankers – and I don’t only mean the presidents and governors – are now giving far more public speeches than they have things to say. Why does the 24-hour rolling news society expect them to tell something different and new every time they pitch up on a rostrum? I suppose that with instant media it’s hard for them to give the same speech twice.

The ECB’s central rate has been at zero since March 2016 even though eurozone GDP has been positive since Q2 2013 and has averaged 0.50% since that last rate cut. It would appear that it has now become incumbent on central banks not to manage economic cycles but to prevent them from happening. It appears that while trying to have the cancer cured, the patient has become a morphine addict.

The central banks have created the mother and father of all asset bubbles and they can see no way out, short of prompting a monstrous collapse. Thus they will sit tight and talk of future normalisation but never give an indication of when the normalisation will happen.

Thus St Mario, patron saint of asset bubbles, will speak of the ECB vigilance, of the need to consider tapering the asset purchase programme – that’s QE to you and me – and of the normalisation of interest rate policy “when the time is right”. How about if the right time is never?

Has anybody noticed how quiet, other than defining his wife’s role as a First Lady without actually being a First Lady, President Macron has become? Readers may remember that after the presidential, but ahead of the parliamentary elections, I noted in this column that a sweeping victory for En Marche would only be part two in a three-part drama and that Macron’s power would only be secured once he had won over the support of the unions for his reform programme. Well, the summer is now coming to an end and the unions are showing no sign whatsoever of wanting to play ball.

The rhetoric from the left is already clear in that cuts to social expenditure will be resisted “à outrance”. The old axiom that one can’t cut expenditure and deficits without impacting GDP is one which governments around the world wrestle with every day. France, with its centuries old tradition of extra-parliamentary opposition, can expect to see resistance to change spill onto the streets again. President Sarkozy, so keen to reform public sector finance, tripped over it and odds are that Young Macron will too.

France’s debt/GDP stands at 96%. In Germany it is 68.2%. It is said that in politics the best way to detract from domestic issues is to focus the people on foreign policy. Macron snuggling up next to Mutti Merkel is nothing other than that. Pease don’t get me wrong; Macron has all the right ideas and he probably has the youth and the dynamism to pursue his policies. What he still lacks is the buy-in from organised labour within the public sector. Although overall union density is low - some estimate as low as 8% - the public sector is still strictly organised with an unusually high density of roughly two thirds of workers carrying cards. As nearly half of all jobs in France are government dependent, it exposes Macron, and his enthusiastic but inexperienced majority in the Assemblée Nationale, to political risk beyond its control.

Currently the 10 year Bund/OAT spread is at 30bp. Ahead of the presidential elections it was in the 80s. That spread now looks very tight to me and now, while nobody else is watching, might be a good time to consider trading it.

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