2016/12/07 Commentary: Draghi’s Dilemma
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COMMENTARY: Wednesday, December 7, 2016
The US equities proved today that they are not too concerned about any problems elsewhere in the world as long as they are not systemic. While their Trump-inspired bull seemed to take a breather into and directly after Sunday’s now failed Italian government reform referendum, it seemed like just a matter of time before they got going again on the upside. In fact, we still believe that these non-systemic problems elsewhere are a fillip for US equities as the improved US outlook draws investment flows from less attractive situations elsewhere. And one of the main alternative developed economy areas is Europe and the Euro-zone. If you are an international business right now, are you inspired to invest and hire in Europe? How does it compare with the previously tax regime challenged US, which is headed for real structural reform (that we have noted since back in early 2015 was the only effective and necessary solution)?
And with the failure of Italian Prime Minister (actually ex- Prime Minister) Renzi’s reform referendum, the situation in Europe is due to become stressful once again. The problem is that there never was an effective resolution of Euro-zone bank capitalization weakness since all the way back in the Greek Debt Crisis into 2010. It seems to be the case that Europe did not want to admit that its banks had behaved as badly in its own credit bubble as the US banks had in encouraging US Housing and Credit Bubbles.
Yet the banks are only part of the broader Euro-zone problem. As the Financial Times’ Chief Economic Commentator Martin Wolf noted in an excellent dissection of the series of problems plaguing the Euro-zone (our marked-up version) in the wake of the Italian reform referendum failure, “…(the Euro-zone) has proved to be a machine for generating economic divergence among members rather than convergence.” His analysis of weak overall Euro-zone economic performance since the 2008 crisis expands to cover very different results in those states that are still struggling versus the much better performance of Germany in particular. And this gets us to ‘Draghi’s dilemma’ in attempting to provide effective monetary policy for a Euro-zone with very different economic performances and potential risks between individual members.
We suspect that even if the Governing Council is going to reduce the asset purchase program, that will be very gradual. It will likely also NOT be characterized as a ‘taper’ (ala the Fed back in early 2013.) This is to avoid any sense a lower level of asset purchases is on a definitive path to termination of a program the ECB wants to maintain.
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