Diary of a Financier

The most important post on Europe you’ll read this year

In Capital Markets, Economics on Thu 9 Oct 2014 at 17:24

There’s a lot of bad news being thrown at the market right now.  Most of it is of the garden variety, those constant fixtures in the everpresent wall-of-worry.  Euroskeptics are perhaps the loudest of the lot right now.  This ilk is framing a much different narrative for Europe than objectively exists, but they’ve managed to talk-down European markets — not to mention the rest of the world.  ‘Uncertainty is the mother of opportunity’ (or something like that), and there’s a particularly attractive entry point in European equities right now.  We are buying Europe ($HEDJ)…


Here’s some backround to start…

The ECB issued a press release last week that disclosed the details of its new, “Private QE” program, which will start with a covered bond purchasing program in the middle of October (this month):

The complete guide to the ECB’s new “Private QE” program | Blackrock
Mario Draghi released the full details of his “asset backed securities & covered bond purchase programs,” which aims to reflate the ECB’s shrinking balance sheet (from €2T currently back up to €3T):
– Start date: covered bonds 10/2014 (“CBPP3″); ABS purchases 2014q4 (“ABSPP”)
– Duration: 2 years
– Eligibility: Primary & secondary bonds within Eurosystem collateral framework; “Greece & Cyprus… are currently not eligible as collateral for monetary policy operations will be subject to specific rules with risk-mitigating measures”

…yet the market penalized Europe for “lack of detail” in that proposal.

So, global markets swooned over the subsequent week.  That appeared to have ended with a material bounce higher yesterday upon the FOMC minutes release, which signaled a Fed willingness to extend ZIRP.

Then, starting overnight, a weak European session bled into a cascading selloff in the West.  The attribution: Mario Draghi.

Everyone honed-in on a comment by Mr. Draghi this afternoon, when he suggested that Fiscal Policy is the most powerful weapon to put European growth on a sustainable path.  The problem is that his words were misconstrued by everyone from Art Cashin to the MSM.  For example, here is CNBC’s translation of what Mr. Draghi said:

Draghi’s dilemma | CNBC
Of course, the ECB cannot do everything, and the market reaction is partly because of increasing lack of confidence in politicians’ ability to deliver the fiscal and structural policies which would reduce the need for asset purchases.

…That is an opinion — paraphrasing that has woven narrative, colored by a negativity bias, upon which the market latched.

Here is what Mr. Draghi actually said — a direct quote:

Draghi vows to fight Eurozone deflation | The Financial Times
“[The governing council is] unanimous in its commitment to take additional unconventional measures to address the risks of a too prolonged period of low inflation… This means that we are ready to alter the size and/or the composition of our unconventional interventions, and therefore of our balance sheet, as required… as the banking sector is progressively cleaned up and the deleveraging process reaches its conclusion, banks will have new balance sheet capacity to lend, and our monetary policy will become even more effective… I expect credit to pick up soon next year…
“If confidence in public finances is assured, the next stage – and this is where we are now – is to exploit the available fiscal space, so that fiscal policy can work with rather than against monetary policy in supporting aggregate demand.”

Objectively, the ECB has pledged to reflate its balance sheet.  That’s at least a €1T commitment just to bring it back to where it was before the TLTRO rolloff began in 2013.Central Bank balance sheets- Fed/ECB/BoJ (2000-14)  The commitment is even more significant since it’s an open-ended pledge to bolster the economy “at all costs,” and it’s directly impacting the real economy by buying both covered bonds and ABS from both primary and secondary markets.  (The Fed’s QE blended Treasuries and MBS, with the latter having the most direct effect on the real economy.)  Further, this “Private QE” has substantial upside were the ECB to play catchup with other global central banks.

Like the Fed’s Ben Bernanke, Mr. Draghi is asking for the supplement of fiscal policy to embolden his initiative.  As with the US’s dysfunctional Congress, the EU won’t likely grant his wish.  There are a number of anecdotal analogues to the Fed’s QE here, but none are more apt than the noise of doubters — among them the hyperinflationistas.

From a pure technical standpoint, have you seen the chart of the currency-hedged Europe ETF ($HEDJ)!?  Daily bull pennant within a larger bull channel at dual trendline support:

HEDJ daily

I always find this negativity bias paradoxical, because in the end the system is rigged for positivity. This is not to say that the EMU doesn’t have longer-term structural or existential problems to work-out; they do, and their issues life-threatening. Just as in the US, Europe’s letting a good crisis go to waste, and their unresolved flaws will come under scrutiny during the next crisis. What I am saying is that Europe is about to do the right thing, because they’ve exhausted all other options. Even Germany is in dire straights now, so politicians will start conspiring for you, Mr. Draghi, instead of against you.


Europe, ebola, ISIS/Arab Spring… again, most of this seems fixable or ephemeral.  I did, however, bring to light the one thing I think may not be, and I’ve been tracking this for a while:

Energy bubble?
2014.10.09 @ 11:46

…more to come on that.


  1. […] a program of QE, up from last month’s 19%.” Not only is the ECB initiating QE, but they’re starting it this week! [Previously: Retail allocations are average & Margin debt back near record […]

  2. […] 4. Valuations: both P/B and ROE are at historic lows relative to US [and PEG too] [Previously: The most important post about Europe you’ll read this year] #Bullish $EZU $FEZ $HEDJ […]

  3. […] maintaining our overweight position in the currency-hedged $HEDJ index.  As of today’s trading, we’re taking new, marginal […]


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