Word Games With ECB Head Mario Draghi

If you buy the major media narrative, Thursday morning ECB head Mario Draghi made a watershed announcement. The bank announced it would reduce—taper!—monthly bond purchases from its present €60 billion pace to €30 billion beginning in January 2018. But they also said they would extend the program’s life from its previously scheduled January end to September 2018. Media further latched onto some fuzzy, hedgy language[i] in Draghi’s statement that suggested future policy would be (in Fedspeak) data dependent.[ii] Stocks rose, which media interpreted as markets celebrating the “dovish” beginning of the ECB’s taper. To us, that's a bit perplexing. We never thought ECB tapering was a negative—in our view, that got the impact of quantitative easing (QE) backwards. Moreover, here is some breaking news from 11 months ago: This isn’t new. The ECB did the same thing last December—they just denied it was a taper then, when they didn’t now.

The reason why tapering didn’t—and shouldn’t—torpedo stocks is effectively two-fold: One, the ECB telegraphed this move months ago. Markets don’t wait around for policy announcements to start acting on them—markets anticipate. The fact the ECB did what it hinted at made this largely a yawn. Second, in our view, QE never supported stocks and the economy the way many presumed. While central bankers talked up this “stimulus,” it really discouraged lending. Banks borrow short term and lend long, profiting off the difference (or spread) between them. QE’s long-term bond buying depressed yields. With short-term rates super low already, their buying narrowed the gap between the two. Less profitable lending meant less plentiful lending. People respond to incentives.

By now, you’d think most would have caught on to the notion that taper fears are misplaced. We’ve already seen the US not only taper QE (meaning they reduced the rate of bond purchases), but begin unwinding it slowly.[iii] No calamity ensued; lending sped; the economy grew; stocks rose. Same deal for the UK. Japan’s asset purchases have also (quietly) slowed of late, although BoJ Governor Haruhiko Kuroda hasn’t called it a taper.

But if you needed more evidence, you could have looked at … well … the ECB. Last December, Draghi announced a very similar reduce-and-extend program, cutting monthly purchases from €80 billion to €60 billion while extending the program from March 2017 through January 2018. That’s how we got to the rates the ECB reduced today! Yet no one called it a taper. Why? There is no material, substantive difference versus the earlier round. Either way, the ECB’s balance sheet will grow more slowly. It isn’t the positioning—that “data dependent” language is more-or-less boilerplate central bank lingo. Upon announcing the Fed’s taper in December 2013, the bank assured the world that “monetary policy was not on a preset course.” Ben Bernanke never used the word “taper” in either announcing or hinting at policy.

The only reason we can find: Mario Draghi adamantly denied last December’s move was a taper, insisting that term meant “reduce toward zero.” But that doesn’t seem to us like a common definition of the term. Moreover, he didn’t claim today’s move was a reduction toward zero—there is that hedgy language! Hence, media theories that this is the landmark beginning of tapering seem disconnected from facts—and really hinge on Draghi not adamantly denying the current move is a taper.

Again, we never thought tapering was likely to be negative for markets. But as watershed moments go, the mere absence of denying one word central bankers haven’t historically uttered is especially weak.

[i] “If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the APP in terms of size and/or duration.” Source: ECB.

[ii] In English that means, “We’ll see. Depends on our potentially biased view of dodgy data that may or may not actually influence inflation, a key metric we are tasked by law with managing.”

[iii] Glacially.