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European Central Bank President Mario Draghi is way past doubling down. But, man, is he good at making investors feel good or what?
Draghi spoke last week after the ECB’s latest monetary policy meeting. I bring this up because of an article in Bloomberg talking about the effectiveness of the ECB’s forward guidance. To be sure, they deserve much praise for generating a major sentiment shift despite an inadequate improvement in the region’s financial system and economy.
In a Bloomberg survey, 77 percent of economists said the ECB’s “vow on (keeping down) borrowing costs has been effective.” That’s up from 68 percent last month and 48 percent when they were first asked in September. The ECB President unveiled the policy in July and said last week that officials chose “firmer words” to emphasize decisiveness and keep a lid on market interest rates.
Another article in Bloomberg testifies to this: Spain Sells Bonds at Record-Low Yield as (Spanish Prime Minister Mariano) Rajoy Touts Rebound.
You can bet that Draghi and the ECB deserve credit for the record-low yield on Spain’s sovereign debt. But I’d be very careful thinking they’ve been able to pull off a recovery in the Spanish economy. In fact, yet another Bloomberg article this week highlights the firm headwinds still in place for recovery in the euro-zone’s periphery: Bailed-Out Euro Nations Expect Painful Challenges to Remain.
I’m with Portugal’s finance minister when he described the initial euro-zone problem as a “crisis of credibility.”
Yes, debt levels were high and exceeded limits set forth in treaties and agreements.
Yes, the economies underwent severe pain due to financial-system shocks from the U.S.-bred credit crunch.
Yes, the monetary union must live and die by the facets of a common currency system.
But the biggest problem, as we’ve seen for the U.S. and Japan, is not necessarily the absolute level of debt but rather expectations over the capacity to service the debt. The trend of rising interest rates making it costlier to service the debt was what made the situation so untenable for policymakers and investors. And it is why the European Central Bank is so adamantly promoting its promise to do whatever it takes. The extent of growth in the economy and labor market is not the issue. What matters is simply keeping rates contained in an effort to maintain a modicum of credibility.
Or is it?
Is there actually concern that the banking system and the economy may not be back on the solid footing it’s so frequently claimed to be these days? Amid all the cheerleading is plenty of evidence to suggest euro-zone economies are not healthy and the growth outlooks remain bleak. But, hey, it’s simply credibility that matters. Which is why we see things like this from ZeroHedge: ECB Eases European Bank Stress Test by 25%, Lowers Capital Ratio Requirement From 8% to 6%.
Does all this mean the euro zone is on the brink of relapse? No. But I’m betting it’s a whole lot more likely than most are willing to admit.
Does this mean investors should run from Europe? No. Not yet, anyway. We’ve seen just how well markets can perform in an environment of weak fundamentals and strong PR campaigns.
What it does mean is that investors should be very careful of external events that cannot be managed by euro-zone policymakers. A retrenching Chinese economy dragged down by real reform could certainly shake up global economic expectations. Or expectations of rising interest rates in Japan or the U.S. could certainly do the trick.
In the meantime, for the euro zone, the show must go on.
Best,
JR
