Todd Harrison: Will the ECB Flip Financial Markets Upside Down?
The specter of negative deposit rates and unintended consequences.
We've spent a lot of time mapping and navigating the technical landscape, and for good reason. The S&P (INDEXSP:.INX) has persistently held the positive side of 1850 seven separate times since it broke out at the beginning of March, which has kept the bulls on the field and scattered the bears among other, tertiary sectors and situations.
You know the drill by now; S's over N's (S&P outperformance of NDX (INDEXNASDAQ:NDX)), biotech as a leading indicator (once IBB (NASDAQ:IBB) 255-260 broke, IBB 215 (the 200-day) emerged as a target), carnage in the highfliers (that has thus far been contained to that space), relative strength in the financials (Turnaround Tuesday tested that trend but BKX (INDEXSP:BKX) 71.50 remains support), transports that are trying to get over TRAN (INDEXDJX:DJT) 7600, and of course, the overseas rip cords below Shanghai 1985, Nikkei 14K, and German DAX 9K.
It's akin to a high-stakes obstacle course with massive rewards for those who navigate it successfully.
The most important news that crossed my eyes yesterday wasn't nestled within the price action, however; it was a column in the Wall Street Journal hinting that the ECB is considering negative interest rates to combat deflation worries. In such a scenario, commercial banks would actually pay the ECB to park their extra cash overnight. The next policy meeting is April 3, which is a lifetime in financial markets but close enough to table for discussion.
Why is deflation the enemy of the state? We first touched on this topic in 2006 and revisited the theme in 2010. Deflation in a fractional reserve banking system means that central bankers have, for all intents and purposes, lost control of the economy. It is an admission of defeat, albeit one that may be unavoidable.
We were speaking about the United States prior to the Grand Experiment; it would appear that we've now exported the Phantom of Deflation abroad.
We could (and likely will) see large-scale asset purchases (quantitative easing), but it is the specter of a negative deposit rate that should raise a collective eyebrow.
Sure, it might work like a charm -- the intention is to spur banks to lend to small businesses -- but there are a cacophony of unintended consequences that might light the fuse on our interconnected global machination.
I, for one, don't believe the next financial crisis will look like the last financial crisis; we, the people, have presumably learned from our mistakes. The crazy dot-com valuations that led to the tech crash might echo in the future (our present), but we'll likely never see that script play through again.
Ditto the credit crunch; everyone was so freaked out by the financial crisis that they've done anything and everything to get their balance sheets in order. It's the classic example of Gambler's Fallacy in that we extrapolate what happened in our past with hopes of protecting our future.
There are several other "release valves," however -- currencies and interest rates among them. While the grand plan is to squeeze money into global stock markets to perpetuate the wealth effect, bifurcated as it is, there will come a point when a gasket will blow off one of the many moving parts within the machination. When that happens, the underbelly of our financial universe -- the quadrillions of dollars of derivatives holding the world together -- will be exposed and vulnerable.
I don't profess to know if a move to negative interest rates will provide that catalyst, but that's the point -- nobody does, because we've never done it before, save an experiment in Denmark.
At the very least, we can take solace in Erkki Liikanen, the Bank of Finland governor who is on the ECB's 24-member governing council. He yesterday said, "The question of negative interest deposit rates, in my mind, isn't any longer a controversial issue."
I hope you're right E, because the entire world is banking on it.
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Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at email@example.com.
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