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MARKET INSIGHT REPORT Alexander Hamilton Draghi By John R Taylor, Jr. Chief Investment Officer Here we are again. The financial world is collectively on the edge of its chair waiting to see what Mario Draghi is going to do at the ECB meeting next Thursday, June 5. The enthusiasm already generated by nothing more than his promise that something would be done is more impressive than the public reaction to the European elections last week; they might as well have occurred with a news blackout. Thank God for the Euro-sceptics or we would not have found the results in the papers. A joke: the pollster asks which man do you like for the Presidency of the EU. Punchline: There is one? Despite a bureaucracy of hundreds of thousands in Bruxelles and other cities, the executive branch of the EU is nothing but a gigantic homogenizer of the ideas of the nation states with almost no face of its own. The only standout personalities working for the core of Europe are the six at the ECB and among them Mario Draghi stands very tall; everyone else grabbing the newspaper headlines and TV minutes works for the nation states. The EU ranks a poor after-thought in the evening news. The only thing people know is how EU regulations have overruled local regulations. Although this is a positive, the EU is judged, as it always has been, by its local effectiveness. Is it helping my standard of living or am I safer with its rules? Europe is judged almost solely on performance from each individuals point of view. There is no European team. The famous Europeans are long dead: Jean Monnet, Robert Schumann, and Paul-Henri Spaak. Today, Europes leaders are often selected from minor countries, a balancing act among the more powerful states which gives those leaders less power. Herman van Rompuy, the unknown President in the joke is a good example. He is from Belgium. Mario Draghi is the face of Europe, even if he only works for the ECB. His previous results and his personality have helped him and the total power vacuum has assured his prominence.
Looking back at the creation of the United States out of a cacophony of states, which actually were far more uniform than todays European ones, one critical economic event had to occur to give the fledgling country a chance: the consolidation of financial risk. One man did that job: Alexander Hamilton. He was a one-man wrecking crew, but he had something Draghi does not have, the support of President George Washington, the man who could have been Emperor. Draghi is alone, he has no mentor, but none can pull him down either. Hamilton had to deal with Thomas Jefferson, famous and powerful in his own right, leading the richest, most solvent, most powerful state who felt strongly that Virginias credit could never be tied to the weaker (all 12 others) states. Hamiltons trick, moving the nations capital to Washington, cutting Jeffersons commute and building a new city with its growth potential, was an 18th century solution. Draghi has to find a 21st century one.
The event next week is not the answer, but it could be the first part of one. Our forecast is for a baby step and the world will be disappointed. They probably are right. The euro needs to go down, but not because the peripherals are falling apart, but because the ECB has willed it. Draghi knows he needs that weakness but he doesnt have enough power to achieve it. However, just starting with the Bundesbank on his side Jefferson institutionalized is enough to set off a global risk-on rally into late August. The ECB is loosening! Unfortunately, its not enough to help the Eurozone. But that is Draghis opening Germany is headed into a recession, and by next year GDP growth will be negative. Merkel and friends the would-be Emperors will be without clothes. Then Draghi can do a Hamilton. FX CONCEPTS FX CONCEPTS GLOBAL MACRO RESEARCH GLOBAL MACRO RESEARCH CURRENCIES INTEREST RATES EQUITIES COMMODITIES To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com
CURRENCY Asia Long-Term View
Buongiorno QE (or some version), Sayonara QE By Joseph Palmisano _____________________________________________________________________________ What you do may be more important than when you do it, but not always, and timing definitely does matter. As we wait for the ECB to do something, anything, and the Bank of Japan to do more, it seems important to put the possible moves into context. As we mentioned in our Market Insight Report, Alexander Hamilton Draghi, the ECB will only take baby steps and underwhelm the markets, which have aggressively priced in an outcome of aggressive easing by taking the EUR/USD down more than four big figures in three weeks.
As for Japan, when Shinzo Abe won the LDP leadership contest in September 2012 and became the clear front-runner for the upcoming elections, the financial markets started to react to his plan (now known as Abenomics) to harness fiscal and monetary reform, along with structural reform, in order to break free from deflation. Perhaps the most successful part of the plan was to weaken the yen and get inflation higher and this worked very quickly. But this is coming to an end. The rhetoric from Kuroda and commentary from the Bank of Japan does not suggest qualitative and quantitative easing (QQE) is on the cards any time soon. The central bank appears to be very comfortable with the impact that QQE has had so far, noting that growth is well above trend, the output gap has likely closed in its estimation, and the Japanese definition of core inflation is likely to reach the 2% price stability target by the middle of the forecasting period, roughly October 2015. We think this is a mistake. If the BoJ does not announce easing in July, it would remove the near-term Japan-specific kicker to USD/JPY moving higher. By continuing to do nothing, the BoJ risks reversing the positive jolt USD/JPY received when Abe first arrived. Thats why we are bearish on the USD/JPY there is a lot more downside to come and our cycles confirm it. The USD/JPY will get support if and when the US yield curve starts to price in higher yields. If we get into a Fed tightening cycle while the BoJ is still in a ZIRP/QE regime, USD/JPY will rise significantly. But that is not our view. In fact, we look for US yields to fall much further in the months ahead. You have a better chance of waiting for Godot.
If the ECB hits only a single rather than the homerun the markets want then the EUR will turn higher, and our cycles tell us this strength can persist for a month or longer. The current strength in the USD/JPY is on borrowed time. We look for a peak by late next week and the 102.40 to 102.80 area should hold; if approached we strongly suggest getting short. The currency pair will then turn lower into the second half of June for an initial low of 101.50, and it could drop to 100.40 as well. The longer-term cycles call for an important cyclical low in the middle of August. Our minimum objective is the 100.40 area and the dollar could go much lower. A close above 102.80 will get us concerned that we are wrong.