Back in 2012, Draghi famously said that the ECB was ready to do ‘whatever it takes’ to preserve the euro.
Although he was talking about keeping peripheral countries within the euro during their sovereign debt crisis, the ECB has developed a reputation over the past few years for exceeding investor expectations with their economic stimulus programs.
That ended yesterday when the ECB failed to deliver the stimulus that markets were expecting and responded by moving stocks, bonds and the euro sharply against the central banks likely intentions.
Draghi announced five measures, saying that the ECB will:
- Cut the deposit rate from -0.2 percent to -0.3 percent,
- Extend their quantitative easing program until March 2017 from September 2016,
- Widen the kinds of bonds they will by to include regional and local bonds,
- Reinvest the proceeds from maturing bonds into new securities, and,
- Provide cheap funding to banks for a longer period.
While the ECB is currently buying €60 billion worth of bonds every month, the markets were clearly expecting an increase in monthly purchases, not adjustments and extensions to current policy. The Royal Bank of Scotland, for example, forecast that the ECB would add an additional €25 billion in purchases to the current program.
As noted in the summery above, markets responded very poorly to the news making it a very bad day for the ECB. Their policy actions are designed to lower interest rates and weaken their currency, but the market response was exactly the opposite of their intended outcome.
Super Mario, as Draghi is often called by market participants, must be very unhappy with the market reaction. He must have known that he has a reputation for under-promising and over-delivering and the mismatch between expectations and reality is surely a sign of miscommunication.
In fairness to Draghi, I suspect that markets overreacted to the news because the severity of the selloff in currencies and commodities probably set off margin calls for leveraged players that can use a lot of borrowed money when investing in bonds and currencies.
If they needed to raise cash quickly, they had to sell quickly, which probably caused more market dislocation – in Wall Street Jargon, it was a short squeeze in a crowded trade (the WSJ had a great headline today: Crowded Trades Collapse).
We’ll just have to see how things shake out in the coming weeks. I take comfort in the fact that the CBOE Volatility Index (VIX) jumped, but not that much – it closed just above 18, well below what we saw in August for example. That could change, but for now, stock investors at least aren’t that worried.
I am also of the opinion that this move wasn’t enough to derail the Fed’s likely rate hike late this month, unlike the jolt in August/September. Again, it’s a little early to make a call, but that’s my gut feeling at this point – and while my gut is substantial, it’s no more accurate than my pinky finger, so stay tuned.