Something big is broken.
Hedge funds – already beaten up by lousy returns or massive losses this year and struggling with redemptions as frustrated investors are bailing out – are now watching their European bets get demolished by an evil surprise: Draghi failed to outdo his own hype.
German investors are largely conservative. They like to put their money in brick and mortar to own something real and profit slowly. People with smaller ambitions squirrel their money away at the bank to collect a tiny amount of interest, back when there still was interest. Many invest in life insurance products for retirement cash flows. But they aren’t big stock-market jockeys.
So when the German DAX today plunged 4.5% within a couple of hours, from 11,315 just before Draghi’s fateful announcement to 10,789 at the close, it wasn’t frustrated Germans dumping their darlings.
The French are even less into stocks than the Germans. They don’t trust them. They like their government-sponsored savings accounts. They like brick-and-mortar investments. They like all kinds of insurance products. So when the French CAC 40 plunged 3.6% even as Draghi was speaking, it wasn’t the French he’d disappointed.
It was his former colleagues and rivals at Goldman Sachs and other banks and hedge funds, and they were dumping European equities.
And neither the French nor the Germans suddenly went out of their way to load up on the euro, though it jumped 4% within hours, a breath-taking move for a major currency, from a seven-month low of $1.055 just before the meeting to $1.098 as I’m writing this.
The euro had dropped 5% from the beginning of October until just before the ECB announcement. Shorting the euro had become the standard bet for hedge funds, based on all the hype the ECB had emitted about how it might ramp up, extend, fortify, and add to its monetary policy instruments, which would in theory whack the euro as part of the ECB’s relentless currency war. It was a crowded trade. Now they got caught in an epic short squeeze.
And European government bonds sold off across the board and yields skyrocketed – “skyrocketed” in today’s zero or negative-yield environment. For example, the German 10-year yield spiked 20 basis points from 0.47% to 0.67% – a 42% move!
The ECB has a special relationship with hedge funds and banks that includes closed-door meetings where it hands them privileged information, allowing them to trade in advance of ECB moves. When this popped on the front pages, Draghi, rather than pretending to be shocked and appalled, defended the practice: “Direct exchanges with … specialised audiences form an essential part of the ECB’s communication policy,” he wrote. They were “integral to its transparency policy.”
The ECB has enriched hedge funds and banks every way it could over the years since the euro debt crisis and bailouts. So what had Draghi done today to cause such uproar among his buddies?
Stocks and bonds started selling off even before Draghi spoke at the press conference, as hedge funds were reacting to the ECB’s statement. It promised a lot of goods for them, for a long time:
- Cutting the deposit rate to -0.3%, thus socking it to savers even more; but it left interest rates on the main refinancing operations at 0.05% and on the marginal lending facility at 0.3%.
- Extending QE to at least March 2017, but leaving the monthly asset purchases at €60 billion.
- Buying more assets with the proceeds from maturing securities “for as long as necessary” to somehow contribute to “favorable liquidity conditions.”
- Buying bonds issued “by regional and local governments” in the Eurozone to monetize even the deficits of cities.
- Continuing its refinancing operations “for as long as necessary….”
In short, it enhances one of the greatest wealth transfer schemes of all times. But it wasn’t enough.
Hedge funds had expected a larger cut in interest rates, with the deposit rate getting pushed deeper into the negative, an acceleration of QE from €60 billion a month to something much higher, and perhaps some new goodies.
In the past, the ECB would relentlessly hype future measures, such as QE, and whip markets into frenzy over them, then on the day of the announcement, it would outdo its own hype and offer even more than had been imagined. Stocks and bonds would soar all along throughout the hype period, get a big boost following the actual announcement, and then soar further until QE would kick off a couple of months later.
He was a master at this dark art. From October 15, 2014, when the QE hype began, to April 10, 2015, shortly after the larger-than-hyped QE became reality, the DAX had soared 45% and euro government bonds had reached stunning valuations, with a large portion sporting negative yields. But after the ECB began buying assets, rather than just talking about it, hedge funds got out. By the end of September, the DAX had plunged 24%.
Draghi’s buddies must have been complaining bitterly about this during the closed-door meetings. That’s when a new round of QE hype started. German stocks began to soar again, and by November 30, they’d jumped 20%. But this time, hedge funds didn’t wait until the new measures actually kicked in before they started dumping. Many of them hadn’t dumped quickly enough last time and got caught in the bear market. They learned their lesson: dump on announcement day!
And this, after seven years of muscular central-bank market interventions and manipulations around the globe, is what “investing” has come down to: betting on the words of a few god-like central bankers, running in a solid herd behind central-bank hype, using privileged information to front-run central-bank announcements, selling assets at a profit to central banks under the QE programs, and profiting from the run-up of even the crappiest stocks and bonds to ludicrous heights.
But it’s not working anymore. Something broke. Instead of making a roaring bull move, markets in Europe dove, and US stocks and bonds got hammered too. And that, if you’re betting on central banks, should put you in a pensive mood.
Investors are already getting bloodied as the Great Credit Bubble in the US implodes at the bottom. Read… “Distress” in US Corporate Debt Spikes to 2009 Level
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
Classic Metal Roofing Systems, our sponsor, manufactures beautiful metal shingles:
- A variety of resin-based finishes & colors
- Deep grooves for a high-end natural look
- Maintenance free – will not rust, crack, or rot
- Resists streaking and staining