The ECB did in fact cut rates and increase the amount of QE it would deliver. But I’ll bet you a dollar to 12 doughnuts that, in the “private communications” the ECB had with various “specialised audiences,” they indicated even deeper cuts.
Why would hedge funds buy 10-year German bonds at very low rates using extraordinarily high leverage unless they thought rates were going lower? They expected rates to fall another 10-20 basis points when they bought those bonds. Depending when they bought the bonds, they may even have had open gains to protect. Furthermore, traders clearly expected the ECB to increase its €60 billion QE pace, not merely extend it.
I have sat with traders in Europe who were deeply confident about what the ECB would do. Now we know the reason why: they are getting the straight poop from deep within the bowels of the ECB.
Except that this time, Draghi could not get enough ECB board members to go along with him. I am sure he could have gotten a majority of the vote, but weak support would have raised too many eyebrows. Imagine the FOMC’s approving a new policy with five dissenters. People would say, correctly, that the Fed was in disarray.
I fully expect to see deeper cuts in Eurozone interest rates – perhaps even cuts into negative territory on the refinancing operations as well as the marginal lending facility.
The ECB under Draghi has been willing to hype its moves and then, when the moment comes, deliver more than it promised. This meeting tells us that there is now considerable resistance to taking rates even further into negative territory. It is clearly not just the German Bundesbank saying “Nein!”
I still think the euro will reach parity against the dollar, but the timeframe has been pushed out. Once-bitten, twice-shy traders and hedge funds may hesitate to go all-in against the euro, allowing the euro to rise even further. I expect this unless Draghi musters a surprise announcement that fulfills expectations at the March ECB meeting.
Draghi has to be frustrated: he lost some credibility last week. Now, when he re-utters the words “We will do whatever it takes,” the market will stay skeptical until he actually delivers. They will no longer believe he can deliver on whatever he promised in his “private consultations.”
Europe faces great difficulties generating any real inflation, and it won’t be long before another nation begins to have Greece-like troubles. The ECB must step up as the euro again comes under pressure.
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