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A “Bazooka” Ain’t What It Once Was

Perhaps you’re wondering, having read breathless press accounts of what to expect from today’s ECB, what a “bazooka” buys you these days in Europe?

Draghi unveiled 3 different forms of additional “unconventional easing” at today’s meeting, more than any other single central bank action at a policy meeting – ever.

And what exactly did that do?

  1. The Euro managed to finish the day higher – despite Draghi’s effort to trash the currency as best he could.
  2. Overnight rates somehow ended up higher – despite the fact the ECB cut them.
  3. And as for inflation breakevens – the whole reason the ECB has essentially emptied the chamber – instead of delivering an all-time blockbuster rally, we’re not even in the top 3 moves… this year.

It turns out a “bazooka” these days… ain’t much.

Behold the “shock & awe” of the ECB emptying a clip on a skeptical market…


A Brief History Lesson

The term “shock & awe” has been a linchpin of warfare since time immemorial. The concept shows up in the works of Sun Tzu & Roman legions noted that “it is often most indispensable to deter & overpower an adversary through a perception of our invincibility & fear of his vulnerability”. In recent years, it was applied during the invasion of Iraq in 2003 when, in the initial stages of the “running start” towards Baghdad, coalition forces dropped more munitions than the USAAF & RAF combined over Europe during World War II.

The term has been vastly overused in the parlance of monetary policy by central banks. As recently as this July, NYFRB President Williams referenced a need to “surprise” markets with more aggressive rate cuts when faced with low rates & slowing growth.

 “When the ZLB is nowhere in view, one can afford to move slowly and take a ‘wait and see’ approach to gain additional clarity about potentially adverse economic developments. But not when interest rates are in the vicinity of the ZLB. In that case, you want to do the opposite, and vaccinate against further ills. When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress.”

– John Williams, “Living Life Near the ZLB”, July 18, 2019.

Interestingly, the active effort to inoculate developed economies against the possibility of distress has also been convincingly argued to make the incremental dose of policy easing less effective. There is a decreasing marginal utility associated with each successive “ease”. The Fed’s own research conference in June of this year investigated the effect at length.

In certain special cases, the determination to fix all that ails an economic region through aggressive stimulus has been successful in warding off buying time against the worst crises.

Enter: Draghi

The classic example that comes to everyone’s mind should be that of Draghi’s now-famous “Whatever it takes…” comment.

Exit: Draghi

The problem for the ECB today, of course, is that… well… they are already well through the zero lower bound. And heading lower. To that end, what might once have been viewed as sufficient “shock & awe” – may now no longer be.

Indeed, overuse of such terminology may threaten to undermine its very efficiency.

The ECB today unveiled a series of monetary policy tools that, 20 years ago, would have been nothing short of an authorization to use nuclear weapons to combat a mosquito problem. The very idea of tiering, QE, rate cuts further into negative territory were – on their own, once upon a time – viewed as so unconventional markets had no choice but to acquiesce & work out the thorny details later.

Today, that’s not so obvious. Consider that forward overnight rates in Europe today had their largest 1-day move in 3+ years. But that move was HIGHER. On the day the central bank CUT rates.

That very idea should be an anathema to sacrificing precious resources below the ZLB to shake loose the market’s collective conscience. But it wasn’t – because of certain mechanical aspects of how “tiering” will work.

Who cares about EONIA, give me the good stuff!

Putting that aside then, let’s consider what other asset classes did today in the context of what they’ve done on days of past “stimulative rate cuts”. Obviously, comparing 1-day moves is a little unfair in the larger scheme of things, but it gives a flavor of how the meeting was received on that day.

Suffice to say, today was not exactly viewed as a “bazooka” for the asset classes listed below.

Those with good memories will recall though that Draghi’s “Whatever it takes…” speech came not at a ECB meeting, however, but at an Investment Conference in London a few weeks later. It was largely in response, some felt, to the fact that the reaction at the July ECB had been somewhat more tepid than expected.

“Whatever it takes”: Then & Now

Let’s compare what happened back then & in the days that followed versus what we saw today – just to get a sense of how much ground might need to be covered.

Here’s what the spread between BTP-Bunds & OAT-Bunds did today (dotted) vs “Whatever it takes…” (solid).

Here’s what fwd EONIA did today (dotted) vs “Whatever it takes…” (solid).

Here’s what equities did, broad market & banks (SX7e).

Here’s what credit indices did (main = IG, XO = cross-over, High Yield).

So, in that context, this is essentially what newly launched combination of unconventional measures looked like…

Okay, so all those failed – but what about inflation?

At this point, you should (rightly) be pointing out that, back then, it was more of an existential question with respect to the Eurozone. Creating inflation wasn’t the first & foremost task in the mind of policymakers: it was making sure the market knew that “breakup” wasn’t an option to be considered (it turns out, that historical accounts of private conversations revealed that things like kicking countries out, breakup, etc – was viewed as a very real possibility by those in senior policymaking circles).

In other words, I’m cherry-picking assets & ignoring the fact that today’s move was about re-igniting inflation expectations. That’s fair. So, how did inflation assets fare today, then?

It does seem as though that was a bright spot in terms of the price action today. Breakevens widened across France, Germany & the Eurozone as a whole.

But, as you can see from the chart above – today’s move, while “large”, doesn’t even rank in the top three daily moves all year for the Eurozone as a whole.

By the way, we’ve got a lot of ground to catch up if we even want to be close to where we were a year ago. Which is still well-shy of achieving the ECB’s stated goals.

Those inflation expectations shown above are also the 5y fwd 5y rates. So, that’s quite a ways off in the grand scheme of things.

Looking a little closer to home in the next year or two, we can see that the so-called “bazooka” and “shock and awe” tactics that Draghi’s deployed in his penultimate meeting as head of the ECB contributed just shy of 0.05% to 1y fwd 1y inflation expectations.

A sobering thought for those who might wonder what a “bazooka” buys you these days in Europe.

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