Features

If Mario Draghi fails to deliver today, there will be a lot of disappointed investors

Markets expect European Central Bank boss Mario Draghi to deliver extra stimulus at his policy meeting today. But can he live up to their expectations? John Stepek weighs up his options and the likely outcomes.

Mario Draghi © Thomas Lohnes/Getty Images

This afternoon, European Central Bank boss Mario Draghi has his legacy moment.

At 12:45pm (apologies to Money Minute viewers the times quoted there were Central European time, not UK time, we'll make sure that doesn't happen again), we find out what's going to happen with eurozone monetary policy.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

Then, 45 minutes later, Draghi stands up and explains it all in detail.

Is it going to be his crowning glory? Or a damp squib?

Advertisement
Advertisement - Article continues below

I don't know. But markets are certainly betting on the former.

The market believes in the Maestro of the eurozone

I don't want to try to second guess what European Central Bank boss Mario Draghi will do this afternoon.

He'll cut interest rates, almost certainly. So the eurozone interest rate will go down from minus 0.4%, probably to minus 0.5%. And he'll probably restart quantitative easing (QE) in some way or other.

Lots of economists think that this is futile, and that the ECB is "out of ammo". Other economists think that a central bank can never be "out of ammo", just lacking in ambition. I tend to side with the latter where I differ is that while I think central banks can always do more, I'm really not sure that they should.

But all the quibbling about whether any of this will actually help or not is not particularly relevant. Markets respond to genuinely looser monetary policy in a Pavlovian manner. It's just what they do.

So the question is just: can Draghi surprise markets sufficiently? Can he be dovish enough to make them rethink their recent bout of panic?

Advertisement
Advertisement - Article continues below

My gut feeling, if I'm honest, is that he probably can. Expectations are high, but Draghi has a record of managing expectations exceptionally well.

The only risk is that it's pretty clear that the market has bought into that idea as well. Investors expect to be pleasantly surprised. Which makes it a lot harder to deliver a pleasant surprise. (Google "Keynesian beauty contest" for more on how markets really work).

So what's changed?

August was rife with fear. Bond yields collapsed to unheard-of levels and gold soared. Investors were suddenly fretting that a recession was nearing, or that it might even upon us.

This has started to change this week. One of the clearest signals (although also one of the most obscure and technical) is that value strategies suddenly started beating momentum strategies.

This was a rapid reversal that most of us wouldn't even have noticed, but it really startled the "quant" community (at the risk of massive oversimplification, the quants are the ones who program the algorithms that everyone worries are taking over the market).

Advertisement
Advertisement - Article continues below

This all suggests that investors are starting to think that the collapse in interest rates has been overdone. (Again, to put it simply, value stocks do better when rates are rising, growth stocks do better when they are falling.)

And I suspect this is at least partly about a belief that Mario Draghi can indeed, do "whatever it takes" before he steps down.

Paving the way for a market melt-up maybe

I pointed out earlier in the summer that, for all the talk of trade wars, the real factor intimidating markets was Europe. If one thing had freaked out markets more than anything (in my view, at least), it was the idea of the eurozone slipping into another recession.

If your mind is still on financial "contagion" and 2008-style risks, then the eurozone is where it is most likely to be unleashed. The contradictions inherent in using a single currency across multiple countries with diverse economies have never really been addressed. That means the necessary political compromises have not been made, or even put to the population.

You can get away with that while the economy is pottering along and no one is really keen to kick up a fuss. The rise of populism helps, oddly. As long as you don't get a critical mass, then the sight of Brexit and outsider political parties helps to shore up the resolve of the "mainstream" (look what's happened in Italy, for example).

But when growth collapses and unemployment rises again, you get even more discontent, you get rising bad debt, and you get risks to bank solvency. All of the problems you skated over last time rear their ugly heads again and it's back to square one.

Advertisement
Advertisement - Article continues below

However, a couple of things have changed. Germany's economic data has been bad, but that's partly about the slowdown in China. China is now trying to stimulate its economy again, which suggests that economies exposed to the slowdown in global trade might get a reprieve.

More importantly, investors reckon Draghi will work out a way to prop up bank profits, while simultaneously making monetary policy a lot easier. And he'll also be able to get past the objections of many of the more hawkish members of the eurozone monetary policy committee in order to do so in a resounding manner.

How will we know if he's pulled it off? I think the most obvious "tell" will be the eurozone banking index. If eurozone banks bounce today, it's a sign that Draghi has convinced markets that they're safe, at least until next time.

Counter-intuitively, we also need to see the euro strengthen. It's hard to have a proper "risk-on" market while the US dollar is this strong. The most obvious route to a weaker dollar index is for the euro to appreciate. Although looser monetary policy typically means a weaker currency, if Draghi restores confidence in the eurozone with his actions, the euro could very well strengthen.

So at a guess, that's what we're looking for a bounce in eurozone banks and a bounce in the euro. A sufficiently convincing package might even clear the way for a climactic market melt-up, leading to a market top where we get the IPOs of WeWork, Saudi Aramco and that stupid scooter company, all within a couple of months of each other.

But let's not get ahead of ourselves. All will be revealed in a couple of hours.

Advertisement
Advertisement - Article continues below

By the way, another reminder to get your ticket for the MoneyWeek Wealth Summit on 22 November I've just been talking to our organisers about a very special guest who I'm hoping I can reveal in tomorrow's Money Morning. Book your ticket now!

Advertisement

Recommended

Visit/519858/how-long-can-the-good-times-roll
Economy

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
Visit/economy/eu-economy/601060/the-european-central-bank-throws-away-the-rulebook-to-bail-out-italy
EU Economy

The European Central Bank throws away the rulebook to bail out Italy

The ECB has removed all constraints on asset purchases and will now buy “whatever it takes” to tackle the coronavirus. John Stepek explains what it me…
26 Mar 2020
Visit/node/601005
Currencies

The euro: will the single currency survive the coronavirus?

The EU has failed to convince anyone that it has either the will or the tools to keep the eurozone together in the face of the coronavirus epidemic.
20 Mar 2020
Visit/economy/eu-economy/600979/get-set-for-the-next-euro-crisis
EU Economy

Get set for the next euro crisis

Italy is almost certainly heading for its fourth recession since the global financial crisis. 
13 Mar 2020

Most Popular

Visit/investments/property/601065/what-does-the-coronavirus-crisis-mean-for-uk-house-prices
Property

What does the coronavirus crisis mean for UK house prices?

With the whole country in lockdown, the UK property market is closed for business. John Stepek looks at what that means for UK house prices, housebuil…
27 Mar 2020
Visit/economy/uk-economy/601063/the-uks-bailout-of-the-self-employed-comes-with-a-hidden-catch
UK Economy

The UK’s bailout of the self employed comes with a hidden catch

The chancellor’s £6.5bn bailout of the self employed is welcome. But it has hidden benefits for the taxman, says Merryn Somerset Webb.
27 Mar 2020
Visit/investments/commodities/gold/601037/gold-is-on-a-wild-ride-so-should-you-be-buying
Gold

Gold is hard to find right now – so should you be buying?

With demand through the roof and the physical metal hard to find, it's not the best time to buy gold. But right now, says Dominic Frisby, you want to …
25 Mar 2020
Visit/investments/stocks-and-shares/share-tips/601035/share-tips-of-the-week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
27 Mar 2020