CBB 2017-03-28T09:32:00+00:00

Credit Bubble Bulletin – Doug Noland

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July 21, 2017: New Age Mandate

A journalist’s question during Mario Draghi’s ECB post-meeting press conference: “…There was a sharp reaction from financial markets to your Sintra speech. You must have looked at the Fed experience of 2013. Is there any concern in the Governing Council that the so-called tantrum or a similar reaction can happen in the eurozone when you start discussing changes in your stance?”

Draghi: “I won’t comment on market reactions, but let me give you the bottom line of our exchanges: basically, inflation is not where we want it to be, and where it should be. We are still confident that it will gradually get there, but it isn’t there yet, and that’s why the Governing Council reiterated the forward guidance, the asset purchase programme, the interest rates and all this package of monetary accommodation; and reiterated that the present very substantial monetary accommodation is still necessary. Let me read the introductory statement: ‘Therefore a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to gradually build up and support headline inflation developments in the medium term.’

Draghi continued: “But let me just make clear one thing: after a long time, we are finally experiencing a robust recovery, where we only have to wait for wages and prices to move towards our objective. Now, the last thing that the Governing Council may want is actually an unwanted tightening of the financing conditions that either slows down this process or may even jeopardise it; and that’s why we retain the second bias, or let’s call it, reaction function. ‘If the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase our asset purchase programme in terms of size and/or duration.’ And I think the Governing Council has given enough evidence that when flexibility is needed to achieve its objectives, it has been very able to find all that was needed. So that’s why we keep this bias.

This exchange gets to the heart of a momentous issue. Recall the swift market reaction to “hawkish” Draghi’s comments from Sintra (June 26-28 ECB Forum on Central Banking) and, soon after, ECB officials expressing that markets had misinterpreted his remarks. Markets this week were awaiting “dovish” clarification. Draghi soundly beat expectations.

The above (astute) question referred to the Fed’s 2013 “taper tantrum” experience. While it received scant attention at the time, Bernanke’s – “The Fed will push back against a tightening of financial conditions” – response to incipient market instability proved a pivotal extension to his historic monetary experiment. In hindsight, this was the chairman’s vague introduction of a New Age Mandate: Central Banks Will Underpin Risk Embracement Throughout the Financial Markets. The Fed was prepared to employ aggressive stimulus measures in the event of self-reinforcing risk aversion and resulting marketplace liquidity issues. The Federal Reserve was signaling that it was ready to respond quickly to de-risking/de-leveraging dynamics – over time profoundly impacting risk-taking and securities and derivatives pricing throughout the markets. (more…)

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