Draghi’s Resilient Euro Recalls Greenspan Conundrum

Photographer: Martin Leissl/Bloomberg

Mario Draghi, president of the European Central Bank (ECB), speaks during a news conference where he unveiled historic measures to face down inflation, in Frankfurt, on Thursday, June 5, 2014. Close

Mario Draghi, president of the European Central Bank (ECB), speaks during a news... Read More

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Photographer: Martin Leissl/Bloomberg

Mario Draghi, president of the European Central Bank (ECB), speaks during a news conference where he unveiled historic measures to face down inflation, in Frankfurt, on Thursday, June 5, 2014.

Then-U.S. Federal Reserve Chairman Alan Greenspan called it a conundrum a decade ago when he boosted interest rates only to see bond yields fall. European Central Bank President Mario Draghi is facing a similar puzzle with the euro.

Rather than retreat from the 18-nation euro, traders scooped it up yesterday after Draghi unveiled unprecedented monetary-stimulus measures including negative deposit rates that should tend to weaken a currency. Traders speculate the moves are likely to boost the region’s bond and stock markets, bolstering their appeal and the currency needed to buy them.

“The magnitude and multi-faceted nature of the stimulus suggests that the ECB’s main goal here is to take a chainsaw to the euro, but the markets are just laughing at Draghi’s slasher mask,” Guy LeBas, the chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said in a note to clients yesterday after the ECB’s decision.

Draghi is counting on a lower euro to help ward off deflation and aid exporters. He stepped up his war of words against the currency’s strength in recent months, culminating in May 8 comments that gains in the euro, which that day reached its highest level in 2 1/2 years against the dollar, were hurting policy makers’ efforts to spur inflation.

Euro ‘Positive’

“The things that matter from a currency standpoint, at least in the short term, did not move the needle in favor of euro weakness,” Alan Ruskin, the global head of Group of 10 foreign exchange at Deutsche Bank AG in New York, said in a phone interview yesterday. “The periphery bond markets and equity markets rallied. That would actually be positive for the euro.”

European stock exchange-traded funds took in $800 million of assets in the five days ended June 3, compared with $200 million in the previous period, according to TrimTabs Investment Research. Those funds have added $2.6 billion of assets in the past four weeks, the firm said in a June 4 report.

Italian two-year debt yields plunged today to a record 0.458 percent, after Germany’s DAX Index (DAX) topped 10,000 for the first time yesterday.

Europe’s shared currency rose 0.5 percent to $1.3660 yesterday, after earlier dropping as much as 0.7 percent to $1.3503, the lowest level since Feb. 6. It was down 0.2 percent today at $1.3636 as of 9:58 a.m. in London.

Negative Rate

The euro’s resilience has confounded strategists expecting a decline as the region grows more slowly than other developed economies. The median estimate of economists and strategists in a Bloomberg survey is for it to weaken to $1.34 by September and to $1.32 by the end of the year.

Both Deutsche Bank and JPMorgan Chase & Co. strategists said yesterday in client notes that they see the ECB’s measures as having a “limited” impact on the shared currency. The euro fell 0.3 percent to 139.47 yen today, after yesterday climbing 0.1 percent.

The ECB cut its deposit rate to minus 0.1 percent, becoming the first major central bank to take one of its main rates negative. In a bid to get credit flowing to parts of the economy that need it, policy makers also opened a 400 billion-euro ($546 billion) liquidity channel tied to bank lending, and officials will start work on an asset-purchase plan.

While conceding that rates are low, the ECB president signaled his willingness to act again.

“We think it’s a significant package,” Draghi told reporters in Frankfurt. “Are we finished? The answer is no.”

2004 Flashback

Greenspan said policy makers in 2004 “ran into what we called the conundrum,” as yields on longer-maturity Treasuries fell, helping to lower mortgage rates, even as the central bank tried to curb lending by tightening credit.

“For decades, every time the Fed raised its short-term rates, the 10-year note, which is really a proxy for mortgage rates, the yield went up with it,” Greenspan said in a March 2010 interview on Bloomberg Television’s “Political Capital With Al Hunt.” “This time it did not.”

Draghi’s announcement is the most dramatic since the summer of 2012, when at the height of the European sovereign-debt crisis he announced his plan to “do whatever it takes” to save the euro. At the time, the currency fell as low as $1.2043 and Italian two-year note yields were more than 5 percent.

“While the outcome was a bit more aggressive than anticipated, the ECB failed to deliver on QE,” Mark McCormick, a macro strategist at Credit Agricole SA in New York, said yesterday in an e-mail. QE refers to quantitative easing, or when a central bank resorts to buying bonds to lower borrowing costs and inject cash into the financial system.

Lower Returns

Draghi is finding his aim of a weaker euro is at odds with investors who see European assets as a bargain in a world where the biggest central banks have cut interest rates to records. Italian 10-year bonds yield 2.81 percent, compared with 2.57 percent for similar-maturity Treasuries.

“People are going into asset markets because they think they should be buying European stocks or peripheral bonds, and that’s typically counter with a weaker currency from a pure flow perspective,” Eric Stein, a money manager at Eaton Vance Corp. in Boston, said yesterday in a phone interview. Stein oversees about $13 billion.

“You continue to lower peripheral bond yields, at some point there’s going to be no reason to own them,” he said.

‘Further Measures’

Hedge-fund managers and other large speculators boosted bets last week to the most since July that the euro will weaken against the dollar. The difference in the number of wagers on a decline in the common currency, compared with those on a rise -- net shorts -- totaled 16,633 contracts on May 27, compared with 9,220 a week earlier, according to data from the Commodity Futures Trading Commission.

“After all the excitement, the euro is pretty much where we started,” Adrian Owens, a money manager in London at Goldman Sachs Asset Management Ltd., which oversees more than $800 billion, said yesterday by phone. “The ECB will be reasonably relaxed and are not hung up on short-term moves. If the euro doesn’t weaken from here, we’ll see further measures. The obvious one would be some form of QE.”

To contact the reporter on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net

To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Paul Cox, Robert Burgess

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