Courtesy of John Nyaradi.
Mario Draghi drops a bomb as pledge to do what it takes turns into a promise to plan
Last week, European Bank President Mario Draghi electrified world markets with his statement that the ECB would do whatever it takes to save the Euro and “believe me, it will be enough.”
Today at the long awaited and much publicized European Central Bank meeting in Frankfurt, Dr. Draghi announced that the ECB will draw up a plan to buy bonds to try to stabilize things in Europe.
He kept Euro Zone interest rates unchanged at 0.75% and said that the ECB “may undertake outright open market operations” and would offer details of any new purchases on an individual basis pertaining to each country.
More importantly, he said that a banking license for the European Stability Mechanism is against the governing treaty of the European Union and this development is a huge hit to potential rescue efforts in Europe as market players and participants have seen this tactic as a way to boost the ESM’s ability to save larger countries like Italy and Spain. Italy and France have been strong advocates of this plan while Germany has opposed the idea.
European markets declined sharply after the announcement and the U.S. stock market opened lower. iShares MSCI Germany Index (NYSEARCA:EWG) fell 1.7% in opening trade in New York and iShares MSCI Italy Index (NYSEARCA:EWI) dropped 2.9% while iShares MSCI Spain Index (NYSEARCA:EWP) tumbled 4.8%.
Spanish and Italian bond yields jumped and the Euro declined with CurrencyShares Euro Trust (NYSEARCA:FXE) shedding 0.12% as the Eurodollar declined to $1.2209.
Wall Street opened lower with the Dow Jones Industrial Average (NYSEARCA:DIA) dropping more than 100 points.
So now in two days we’ve had back to back disappointments from the world’s two most important central bankers. Yesterday Dr. Bernanke and the Federal Reserve failed to offer any further monetary relief and today Mr. Draghi was unable to deliver on heightened expectations for intervention. Last week’s powerful rally was driven by the hope that further central bank easing would be forthcoming and it did not happen, at least for this week. Global markets have been programmed to expect the “cavalry” to ride to the rescue and so have been disappointed now two days in a row.
So what does it all mean?
On our side of the Atlantic, the Federal Reserve is running out of options and has said as much. Further easing brings its own set of dangers and is not the ultimate solution to weak demand and low growth. The Fed can set an environment of low interest rates in hope of increasing demand but can do nothing to directly stimulate the economy. That would have to come from the government and with the election season fully underway and gridlock on Capitol Hill, no help from that quarter can be expected.
In Europe, the situation is even more problematic as Europe is not really a union but a collection of states with a common currency but wildly differing agendas and priorities. The Northern countries are digging in against the South and Mr. Draghi and the European Central Bank is caught in between. The Bundesbank is a major player and is opposed to bond buying plans and so this will be a tough sell for Mr. Draghi going forward.
Finally, all of this is set against the backdrop of a slowing global economy and ongoing problems with Greece and Spain that are bound to escalate with each passing day. The United States, unfortunately, is not a bystander as large percentages of S&P profits come from overseas and the drag of Europe is already showing up in current weak earnings reports.
Bottom line: Europe remains a powder keg and we can expect more volatility ahead.
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