Friday, January 18, 2013

Take a Bow, Mario Draghi

Bullish sentiment has gotten so widespread in recent weeks that even the Fed is concerned.

Here was an excerpt from a Bloomberg article earlier this week:

ECB president Mario Draghi speaks on July 5, 2012 in Frankfurt am Main at the press conference after the meeting of the Governing Council.Federal Reserve officials are voicing increased concern that record-low interest rates are overheating markets for assets from farmland to junk bonds, which could heighten risks when they reverse their unprecedented bond purchases...

Now, as central bankers boost their stimulus with additional bond purchases, policy makers from Chairman Ben S. Bernanke to Kansas City Fed President Esther George are on the lookout for financial distortions that may reverse abruptly when the Fed stops adding to its portfolio and eventually shrinks it. 

“Prices of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels,” George said in a speech last week. “We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances.”

The article goes on to note that Bernanke has set up a new department at the Fed (with the pithy title of "Office of Financial Stability Policy and Research") specifically to monitor asset prices and possible areas of "irrational exuberance".

It so long ago, but it was only last year that many policy makers and economists were convinced that we were on the verge of another global economic collapse.

Then European Central Bank (ECB) head Mario Draghi came to the rescue.

When the President of the ECB vowed last summer that it would do "whatever it takes" to save the euro, many were skeptical, and doubted that Draghi and the euro block had the resources and the will to act.

But it worked.

Here's how Bloomberg Businessweek described it in an article published this week.  The article notes that so far at least it has been Draghi's words alone that turned the tide in Europe.  No funds have been needed, only Draghi's "bluff":

Against long odds, Draghi’s bluff worked. Bond markets rallied on the belief that the ECB would deliver on its promise. The market’s surge fed on itself, adding to Draghi’s credibility...

Amazingly, the ECB has not had to follow through and buy a single euro’s worth of Spanish or Italian bonds. The open-ended commitment to do so was enough to get private investors to buy. Borrowing costs in the two countries are affordable once again. As the global elite convenes in the Alpine resort of Davos, Switzerland, for the World Economic Forum on Jan. 23-27, the European economy looks a good deal less scary than it did a year ago. For that, Europeans can thank the unassuming moneyman they call Super Mario. Even Germans are impressed. “I was way more critical—I have to admit that—in September than I am today,” Nikolaus von Bomhard, chairman and chief executive officer of reinsurer Munich Re, said in a Jan. 15 interview.

Even Spain - which last summer was roiled by protests against the ECB-imposed fiscal cutbacks - has found markets eager to buy their debt.

Here's how what the New York Times reported yesterday:

January is turning out to be a bumper month for Spain and some of the euro zone economies most in need of debt financing, with governments and companies flooding the market with bonds that have sold at significantly lower interest rates than just a few months ago.
On Thursday, the Spanish Treasury sold €4.5 billion, or $5.9 billion, of debt, including bonds with a maturity of as much as 28 years. The average interest rate paid by Madrid on two-year bonds was 2.71 percent, down from 3.36 percent in December — a level not reached since March of last year. 

The interest rate on the benchmark 10-year Spanish bond stood at 5.03 percent Thursday. Last year that rate spiked above 7 percent — a level that many economists believe places an unsustainable burden on governments. 

The sustainability of today's bull markets is still being questioned, but there is no question that the sense of fear and panic has left the capital markets around the world.