Will Yellen and the Federal Reserve simply stand idle while Draghi and
the ECB one-up them by increasing both the quantity of "Quantitative
Easing" purchases and the length of the program? Because last Thursday
the ECB announced that it plans to increase the scale of their QE
printing program from 60,000,000,000 a month to over 80,000,000,000 USD
per month, or exactly 1,075,200,000,000 USD annually, which makes the
ECB's annual bond purchases 55,200,000,000 greater than Fed's most
recent QE program. Furthermore, in addition to extending the length of
the program to 14 months, Draghi also made it clear that the actual
length of the program could be indefinite if economic circumstances
render it "necessary."
The primary concern for the Fed is offsetting the potential effect that
an Infinite Draghi Put could have on the dollar. Draghi has made it
clear that he will stop at nothing in order to avoid deflation and hit
the ECB's 2% inflation objective, as evidenced by his remarks regarding
QE, stating that the end date of the monetary easing program is
tentative and did not make any reference to a maximum threshold for QE
or a minimum threshold for interest rates. Since low velocity of money
in the euro area has dampened the inflationary effects that one would
expect from the ECB's QE, and forecasts for sub 2% global growth do not
provide any clear tailwinds for economic activity, Draghi has, and will
continue to have to, resort to printing/devaluing the Euro in order to
meet his unilateral inflation objective. Draghi telegraphed this to
markets by announcing an increase in bond purchases at each consecutive
one of the previous three ECB press conferences (will Greece be getting
any of that free money? I think not. They'll be left to fight it out
with the IMF for temporary revolving loans to keep their government from
collapsing.
Brexit Grexit, anyone)?
The problem is that the Fed, too, has inflation objectives; the Fed,
too, wishes to avoid deflation at all costs; and a weaker Euro resulting
from Draghi's kamikaze policy necessarily implies a relatively stronger
USD, of which the Fed has little utility, in terms of its dual mandate.
Notwithstanding, Draghi and the ECB waited until the Fed washed their
hands of QE before unleashing the mother of all QEs: an increase in the
ECB's QE program by +33, an extension of the program until well after
the US elections (and "further if necessary"), topped off with negative
borrowing costs. Draghi appears to be in the exact position that Yellen
wishes to be in, given that it has been eight years since the last
recession, the business cycle is currently overextended, and QE with
NIRP is likely the only option to cushion a severe slowdown.
On the other hand, Yellen and the Fed are in a relatively opportunistic
position; they have more room to move than the ECB does, as the 10Y is
still well over 1%, they haven't been forced to take rates into negative
territory, and they still haven't done a Reverse Operation Twist or
QE4. Slowing global economic growth as forecast by the IMF earlier in
the month may mean the Fed will be forced to use those tools, however,
optionality gives them relative strength, as all of the ECB's cards
appear to be on the table.
Draghi's decision to ramp up QE even further and extend the program
indefinitely is certainly an impediment to the Fed in terms of its
ability to maintain downward pressure on the dollar while entering into
the final stages of the present business cycle.
