Photo by Phil
Ok, I admit it, I am one of those people that watch the World Series of Poker on ESPN every year. It's not because it is good television or even that I like poker, it is simply that I like watching people attempt to win using a number of interesting strategies. Sometimes players will be loud and almost belligerent, others will be quiet attempting to hide any emotion and even covering their eyes and wearing hoodies, finally others will talk and blab in an effort to throw off their opponent. The competition is a perfect mix of bullying, guile, and negotiation all in a venue that is shockingly rewarding to the final winner.
We've discussed how the markets continually are positioned to offer binary outcomes and frankly I hate them! We face some serious issues this week where the direction of the market will certainly trade based on two huge headline events that happen tomorrow (Sept 12) and Thursday. First, the German high court will weigh in on the constitutionality of the ECB's measures and determine if there is a violation of the German constitution. Second, the Fed will meet and the market expects some further market stimulus probably in the form of continued low interest rates, cessation of payments on excess reserves, and more "twisting" by targeting the yield curve and buying specific treasury bonds. It is pretty obvious, if the German courts rules against the ECB's moves or the Fed only partially delivers stimulus in the form of more QE, we probably see markets go down significantly.
DRAGHI GOES ALL IN
As if there wasn't already pressure on the German high court, ECB head Mario Draghi doubled down in the past couple of weeks and issued statements that the ECB would begin unlimited bond purchases of countries that had yields that "were not reflective" of real market pricing. In otherwords, the ECB just promised unlimited bond purchasing to manage rates and keep them under the critical 6%, 7%, or 8% level (who knows what really is critical now as 6% was the key rate).
By issuing this promise, Mario Draghi simply pushes all the ECB and Euro's chips into the pot and has demanded that market participants fold in the face of an overwhelming and serious threat. The question that investors, traders, and speculators must ask is, "Does Draghi really have anything in his hand?"
ROYAL FLUSH OR HANDFUL OF CRAP?
So, despite the back drop of the two headlines this week, the real story is the ECB's head and his promise to save the Euro no matter what. The bet sounds convincing and seems to have been exactly what markets needed to hear to drive investor confidence higher. I've read a number of bullish stories that emphatically state that the Euro is saved and there will soon be a rush to purchase fire-sale priced European assets as the fix will stabilize markets and put a floor under them. The USD and Euro have been trading like it is Draghi's pot too.
So what could lead us to believe that perhaps the ECB Chief doesn't really have a royal flush? What didn't get much attention in Draghi's announcement is that all of the unlimited purchases would be contingent on the nation receiving aid to comply with full austerity measures and submit to the IMF and ECB conditions. In otherwords, Spain and Italy will be required to become Greece-like and bow down and implement processes they just haven't been willing and able to do. In otherwords, Draghi's promise is based on the requirement that distressed nations reign in spending and raise taxes even more.
PUSHING PEOPLE AROUND
In reality then, Mario Draghi probably has nothing in his hand, but he probably was able to win the pot as his competitors don't have a strong hand that would be worth challenging such a bold and overwhelming bluff. Effectively, the ECB has played a similar hand to what the Fed has and the all-in moves force reasonable players in the markets to simply bow out and hope they can survive and capture a hand on better terms.
Ultimately, sterlization of bond purchases won't do the trick and rates for distressed sovereign nations will get out of hand, but the Fed's and ECB's strategy has nothing to do about winning long term, these players are only interesting in winning the next few hands and extending the game as long as possible.
While I don't think we'll see any shocking news coming from the next two days, I suggest that you review your positions and watch for a continued move higher in commodities and metals. While we are promised that sterlization and QE hasn't produced inflation we need only look to the charts of gold, silver, oil, and corn to note that central banker promises, bluffs, and all-in bets produce commodity charts that go up and to the right.