QE Conundrums – Draghi’s Misguided Intervention?

Key Takeaways:

  • Eurozone equities are Bullish TRADE and TREND (see levels below). Tactically we are recommending shorting France’s underperformance via the etf EWQ.  (See France GIP model below)
  • Draghi’s latest comments (last Friday) have accelerated the prospect of sovereign QE  – Draghi said the ECB must drive inflation higher “as fast as possible,” and the Bank will broaden its asset-purchase program if needed to achieve that
  • The market’s expectations on timing of potential sovereign QE have also accelerated – the Bank has targeted the Q1 2015 horizon, and we do not think the ECB will be ready to act at its next meeting on DEC 4th. In addition, we would caution that legal and political (German in particular) hurdles are still plainly apparent. QE may in fact NOT be a snap of the fingers
  •  On balance over the shorter term, we expect EUR/USD (etf FXE) weakness (broken on its TREND and TAIL durations – chart directly below),  and equity strength
  • We do not expect that the ECB can will growth through financial engineering, and the rate of change of the quarterly “comp” will remain difficult for at least the next 3 quarters (see Eurozone GIP chart below)
  • Our intermediate-term bearish bias on the economic region remains grounded in our Q4 2014 Macro theme #EuropeSlowing

QE Conundrums – Draghi’s Misguided Intervention? - vv. eur usd broken

Economies are not financial markets – this point is not to be confused.

The Hedgeye macro team continues to tout that central planning will not fix the economies across the globe; the interventions have everything to do with trying to resuscitate drowning inflation expectations, and in the short run may inflate stock markets.

Specifically, ECB President Mario Draghi’s speech in Frankfurt last Friday once again tilted expectations. He said the ECB must drive inflation higher “as fast as possible,” and the Bank will broaden its asset-purchase program if needed to achieve that.

Read: Open the sovereign QE buying flood gates!

QE Conundrums – Draghi’s Misguided Intervention? - z. EL 11.24 Mid pic

But, but, if expectations are the root of all heartache, massive amounts of hospital beds will be needed given the indecision of both the ability and impact of issuing QE. Here’s select commentary over recent days:

  • Victor Constancio (ECB VP) said that the ECB will consider buying government bonds in the secondary market if the current measures prove insufficient. He went on to say that the ECB would wait until Q1 2015 to gauge the impact of current programs.
  • Jens Weidmann (Bundesbank President) said there are high legal hurdles for ECB to buy government bonds and that monetary policy alone cannot lead to growth.
  • Ewald Nowotny (Austria Central Bank President) said that Q1 2015 was too early for taking further measures to boost the Eurozone economy and does not see a point of time where that could happen. He pointed out that the ECB has taken a series of measures and should observe the impact of these.
  • Benoit Coeure (Member of the Executive Board of the ECB) said the ECB won't make a hasty decision to add more stimulus and will hinge any measures on incoming economic data. He added that there is unanimous agreement on the Governing Council that situations may arise where it has to do more.
  • Victor Constancio (ECB VP) said that Europe is not at risk of sliding into full deflation but the current rate of inflation is dangerously low. He said that living with inflation so close to zero is dangerous because it makes it harder to repay public and private debt, and impedes economic growth.
  • Klaas Knot (Dutch Central Bank President) said that the ECB could move to take additional easing steps, including purchases of government bonds, but it is uncertain whether this would be effective to fight low inflation. He was skeptical on a sovereign debt-targeted QE program because many governments were already borrowing at historically low rates. In addition, he said that the prior measures would take time to feed through.

Despite heightened expectations that the Bank may act when it next meets on December 4th, we doubt that the council will be ready to act. Specifically, it only just started to purchase ABS (November 21) and the 2nd tranche of the TLTROs will only be allocated a few days following the ECB meeting. Further, we do think VP Constancio’s reiteration of Draghi’s dovish remarks and Q1 2015 timetable offer clear evidence that the bank will wait until 2015 to act. 

Q) What’s Fallen?  A) the Data


Growth & Expectations Down – while a classic lagging indicator, the OECD in its latest Economic Outlook warned that the biggest worry for the global economy is the Eurozone falling into a persistent stagnation trap. The OECD’s downward growth revision brings it close to Hedgeye’s forecast (see GIP model below), however we are not of the camp that a sovereign QE program (like the ABS, covered bond, or TLTROs) will in and of itself lift growth. Here’s a look at the revised forecasts:

  • Eurozone GDP Forecast:
    • 2014: +0.8% vs prior +1.2%
    • 2015:  +1.1% vs prior +1.7%
    • 2016:  +1.7%

QE Conundrums – Draghi’s Misguided Intervention? - vv. EUROZONE

Inflation Expectations Down – 2014 is the year that Draghi has attempted to resuscitate drowning inflation expectations, but so far, he continues to fail miserably. Even with the prospect of QE, we don’t see much of a shift upwards (the ECB target is below but close to 2%). As our GIP chart shows, we expect CPI for 2015 at 0.7% versus Bloomberg consensus at 0.8% and its current level of 0.4%.

QE Conundrums – Draghi’s Misguided Intervention? - vv. cpi draghi

Sovereign Bond Yields Down – with growth and inflation expectations lowered and the heightened prospect for the ECB to buy sovereign bonds, it comes as no surprise that sovereign bond yields are approaching all-time lows. Below we want to flash a chart that shows in particular the periphery dramatic declines in the cost of capital and interestingly, that at 1.98% and 2.16% for Spain and Italy respectively, their 10-year yields are both lower than the 10-year for the United States at 2.24%. 

QE Conundrums – Draghi’s Misguided Intervention? - vv. sov yields

Short France (EWQ)


On 11/24 Keith added short France (via the etf EWQ) in our Real-Time Alerts. We presented this investment idea in our Q4 2014 theme of #EuropeSlowing, expressed as short “Socialism”.  As we show in the GIP chart directly below, there’s a giant delta between our growth expectations and those of consensus.  We therefore expect the economy and its equity market to underperform the region and fortuitously shorted EWQ at the top of its immediate-term risk range.  The CAC remains broken TREND @ 4388 as we show in the second chart below.

QE Conundrums – Draghi’s Misguided Intervention? - vv. FRANCE

QE Conundrums – Draghi’s Misguided Intervention? - vv.  cac

 

Long European equities as long as TRADE and TREND hold (etf EZU as potential investment vehicle).

As we show in the chart below, the STOXX Europe 600 is bullish TRADE and TREND. We’ll be managing this position closely, as again, we see little prospect of Draghi’s QE halting a continuation of decelerating inflation and growth, which we expect to be reflected in the equity market over the intermediate term.

QE Conundrums – Draghi’s Misguided Intervention? - vv. stoxx600

A wonderful Thanksgiving to you and yours!

Matthew Hedrick

Associate