Here is What Draghi And The ECB Have Just Unleashed Upon The World

Here is What Draghi And The ECB Have Just Unleashed Upon The World

On the heels of yesterday’s announcement by Draghi and the ECB, today one of the greats discussed what the ECB has just unleashed upon the world.

Here is a portion of today’s note from Art Cashin: The Key To Draghi’s Proposal – My good friend, and fellow market veteran, David Kotok of Cumberland Advisors wrote a brief analysis on a key feature of Mr. Draghi’s proposal last week. As with everything David writes, it is clear and insightful. Here’s a bit:

Draghi and the ECB announced that they will start a series of targeted longer-term refinancing operations (TLTRO). The first will occur in June 2016. The term will be four years. The cost of this borrowing by a bank is likely to be a zero interest rate. But under certain conditions it will be at the negative policy rate. Thus the central bank will be paying the commercial bank to borrow from it.

Imagine what would happen in the United States if the Federal Reserve structured a program so that any bank, whether Bank of America or your local community bank, were to be paid by the Fed when that bank borrowed from the Fed and used the funds to make loans to you or to buy assets in the market. Right now in the US, banks take their excess funds that are not used for loans or assets and deposit them at the Fed. For an overnight deposit the Fed pays the bank an annualized rate of 0.50%. But the American bank is then charged a fee by the Federal Deposit Insurance Corporation (FDIC), so the net amount it receives from the Fed is less than the gross 50 basis points that the Fed pays. Essentially this transaction is a transfer from the Fed to the FDIC, which really means it is a transfer from the US Treasury to FDIC, since the Fed’s marginal dollar ends up being sent to the US Treasury anyway.

Let’s go back to Europe. There are 19 countries, and each of them has a national central bank. Within those countries are commercial banks. If a commercial bank raises its eligible loans by over 2.5% by January 31, 2018, that commercial bank will be paid 40 basis points on the TLTRO. If the bank fails to increases its loans, it will pay zero for the use of the funds it has borrowed from the national central bank. Note that the national central bank is a conduit for the ECB policy.

So, at the current levels in Europe, a bank can obtain TLTRO at zero and has an incentive to add to loans and assets in order to get the 40-basis-point bonus. Also note that a bank can use the TLTRO to fund certain debt instrument maturities as they come due; thus the interest margins at these banks is likely to improve.

President Draghi has launched a subsidy program to save European banks and make them more profitable. He has added that safety net to an expanded quantitative easing of about a trillion euros a year with expansion of the list of ECB purchasable items to include corporate bonds.

This is a massively expanded stimulus program. It has extremely bullish implications for financial assets and for asset prices in Europe. And because of its size and lengthy term, it is a bullish force for the entire world. We expect other NIRP jurisdictions to use their version of this model. Keep a sharp eye on Japan’s next move deeper into NIRP.

As you can see, David is very excited about these new moves and believes they may spread and have a pronounced effect on assets around the globe.

Overnight And Overseas – The yen firmed when the BOJ stood pat as expected. The BOJ said inflation expectations were lower and that further easing may be needed. The Nikkei fell. The China yuan is a bit weaker. Hong Kong and Indian markets are down, while the Shanghai is flat.

European markets are generally lower with polls showing a slight edge to British voters who lean toward leaving the EU. Russia announces new austerity moves as oil price pinch sinks in.

Gold is down again as is crude. The euro is a bit lower as are U.S. equity futures.

Consensus – Early look suggests bulls may have their work cut out for them if they want to have a typical pre- FOMC rally day. Weakness in crude is a factor.

Tomorrow won’t just be about the FOMC statement and press conference. We will have election results and maybe a clearer picture of where we’re going.

Stay wary, alert and very, very nimble.

KWN
Art Cashin
March 15, 2016