How do I dove thee? Let me count the ways

OK, first things first.  While there were a number of real-time interpreations of yesterday's ECB meeting, from Macro Man's perch it what pretty unequivocally dovish.   How do I dove thee?   Let me count the ways:

1) The total committed purchase size of EUR 540 billion (9 months x 60 per) was larger than the consensus expectation of 480 billion (6 x 80 per).

2) While the initial reaction focused on the lower monthly purchase amount, the vital qualifier (both the monthly amount and the duration may be revised up as circumstances warrant) was dovishly asymmetric.   60 bio is a monthly floor, not a ceiling, and the "full whack" size is guaranteed for a quarter longer than expected.

3) Far from hinting at a taper, as recently rumoured and feared by the market, Draghi was explicit as could be that this does not represent a taper.  We can all probably agree that the ECB isn't going to stop QE cold turkey come year end, so it's a question of when rather than if they start to taper.   Even if they choose the earliest possible time frame (ie January 2018) and adopt a Federal Reserve style pace for tapering, that keeps the asset purchase program going through October of 2018- nineteen months longer than was committed before yesterday's meeting.  That's a long time.

4) The decision to purchase bonds below the deposit rate instead of increasing the ISIN ownership limit was a dovish surprise and should serve to keep front end govvy yields very low.   The Schatz loved it, rallying 20 ticks at one point during the day.


5)  The inflation forecast for 2019 was lower than expected at 1.7%.   This provides a signal that the ECB thinks it is still some ways towards attaining its policy goal, and Draghi was at pains to articulate that 1.7% is not close enough to 2% for comfort.   The upshot is that this suggests that the ECB may well expect to carry on the current policy regime beyond the current explicit and implicit endpoints.  The 2018 contrast with a post-Yellen Fed couldn't be starker.

One of the more interesting aspects of the whole exercise yesterday came with the very last question of the press conference, when Draghi responded to a question on securities lending by unveiling a new cash collateral policy for Eurozone repo markets.   You will never find stronger evidence of a planted question- why wouldn't Draghi have unveiled the policy earlier unless he knew he'd have an opportunity if no one asked?   One wonders how many other questions at the ECB and Fed pressers are planted; in the case of the latter, it's often felt like "all of them".

Although Macro Man was not expecting this sort of reaction ex ante, he did sent out a tweet when the euro was 1.0825 right after the initial decision hit that he thought the reaction was a fade, and so it turned out to be.  While it's easy to say "the ECB hasn't got anything else in their locker", they clearly do; Draghi specifically cited the possibility of jacking up the size and/or duration of what was announced yesterday.   As such, further euro weakness is probably on the cards, barring some sort of dollar shocker.

The biggest beneficiary of the announcement looks to be Eurozone banks, given the perhaps inevitable curve steepening that has already taken place and may further ensue.  Yes, there is plenty of detritus on EZ bank balance sheets, but this isn't exactly a revolution from the blue, and a stark improvement in the earnings environment should re reflected in the price.  If you didn't know what the SX7E chart below was, you'd say it looks pretty darned bullish.  technically, there's quite a bit of fresh air to the topside before we hit a congestion level at 140.


Of course, owning EZ banks makes you feel vulnerable to headline risk, and with good reason.   But the facts have changed a bit, and even with the recent rip the SX7E has lagged its US counterpart by quite a bit.

It's a well known phenomenon that even turds start floating as a bull market matures.  So even if you disbelieve the ECB interpretation and any improvement in earnings fundamentals, you can hang your hat on the rally as one of the last dominoes to fall before reality bites.



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Unknown
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December 9, 2016 at 9:21 AM ×

They were always going to extend. Extending at a lower rate is hawkish. Everything draghi said was sugar coating the fact that he had to taper, which judging by your commentary he bamboozled the market pretty successfully.

60bn floor/ceiling is misleading. The current policy is 60bn. To increase they will have to decide it's warranted. They could equally have the "high class problem" of having it to lower it in response to better data. Their hands are not bound in either way.

Draghi is not going to do his 180 hawkish conversion until he is sure this bounce is locked in. That could be in 3-6 months.

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abee crombie
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December 9, 2016 at 10:42 AM ×

Thanks for the analysis mm, i havent been paying attention. Lets see if eur breaks the range. Aside from eu banks, eu autos catching a bid as well. This all seems like fun and games, eu and jp like a lower currency...until china reaches a breaking point, which who knows when is.. Anyways im just thinking about how manic sentiment is and how fading concensus has been a good trade ( but not awlays infallible) past few years. At the beginning of year you couldnt get anyone to buy a steel or financial company. Now the market cant get enough of either. Funny how things change in a few months.

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abee crombie
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December 9, 2016 at 11:58 AM ×

Thanks for the analysis mm, i havent been paying attention. Lets see if eur breaks the range. Aside from eu banks, eu autos catching a bid as well. This all seems like fun and games, eu and jp like a lower currency...until china reaches a breaking point, which who knows when is.. Anyways im just thinking about how manic sentiment is and how fading concensus has been a good trade ( but not awlays infallible) past few years. At the beginning of year you couldnt get anyone to buy a steel or financial company. Now the market cant get enough of either. Funny how things change in a few months.

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Anonymous
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December 9, 2016 at 1:44 PM ×

Equities are climbing higher again as the Yen weakens. Why does this correlation always happen? Is it Bank of Japan selling Yen and buying equities or what?

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washedup
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December 9, 2016 at 2:21 PM ×

@anon the fundamental premise since the 90's has always been that japanese capital is the marginal source of 'risk on' capital. I am personally not sure the relationship is that strong any more, so its mostly a forced correlation that lives on through quantitative strategies and algorithms calibrated to, um, their own actions over the last 15 years. One of the biggest in sample biases in the world of finance, so to speak.
At some point in our lives we will see a weaker yen as a source of risk-off. The number of algos that fail in that world will be quite epic. The other candidate for that hall of fame award is the stocks and bonds correlation, of course. Not sure which comes first.

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Maverick
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December 9, 2016 at 3:20 PM ×

Good article MM.

My favorite part of Dr Aghi's comments on the press conference was when he suggested the ECB wants to remain a force in the market... to exert a pressure on the market... but not to distort prices. ECB communication straying further into post-truth territory there. Then again, in this post-Brexit, post-Trump delusional euphoria that we find ourselves, perhaps it's not too out of place.

European banks are now down only 7% YTD, which is pretty remarkable, considering the type of year they have had and the fact that the same problems remain unsolved in certain countries and will surely continue to roil markets in 2017. Perhaps, more surprising is CoCo performance YTD: +4.4%... indeed, after the first wave of sell-offs at the start of the year to 11 Feb, AT1 performance suffered almost as much as the overall banks index (-15% vs -17%), however, between 11 Feb and 7 Jul (the nadir YTD, driven by Brexit), there was clear credit-stock divergence, with AT1s rallying >6% while bank stocks suffered a further 14.5% fall - possibility as focus shifted more toward bank profitability woes rather than capitalization levels (which were overall ok, and much better than pre-crisis, albeit lower than the US).

Since the 7 Jul nadir, Europe bank stocks have rallied >44%, so the recovery in bank stock investor sentiment long preceded the recent reflation, de-regulation themes. Yes, the latter has given the upside a further leg up, but the overall behavior can basically be traced to shifts in the German curve, with considerable flattening between 1 Jan and 7 Jul (the 10yr and 30-yr rallying by 80 and 110bp, respectively), followed by considerable steepening since 7 Jul. i.e. bank capitalization concerns largely dissipated by mid-Feb, and the focus shifted to earnings in a low growth, low interest rate environment.

Interestingly, on the inflation front: EUR 5y5y fwd infl. swaps are at 1.73%, continuing an uptrend that started in September. EUR medium term inflation expectations increased by just under 19% since Trump vs a 12% rise in the US rate - no doubt largely due to to the decline in the EUR, and bets of parity vs USD on the cards in 2017. Not to mention recent signs of improvement in the Eurozone economy.

Dr. Aghi notably mentioned signs of an end to the deflationary threat in Europe, so from that perspective, ECB QE partly achieved its objective.

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washedup
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December 9, 2016 at 3:48 PM ×

@maverick the biggest irony here is that no one really knows whether the banks fortunes are even linked to steepening, least of all the banks themselves - I assure you no one at these places has a clue what they own - its all a confidence game.

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Leftback
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December 9, 2016 at 3:57 PM ×

Hmm… Monte Paschi sold off hard this morning and the other Italian banks followed. Perhaps the morning is wiser than the evening after the doctor's visit yesterday? We're inclined to agree with "Unknown" that extension of the program was always going to happen and the decrease in rate of purchases (necessitated by a shortage of bonds to buy) does in fact constitute a taper of the program.

@washedup, agree, there is an assumption that steepening curves are unequivocally good for US banks as well, and obviously they can't make money with a flat curve, and NIRP was clearly an impossible and unsustainable situation for their business model. Still, people need to realize that it's not a one-way street - with the bank balance sheets chock full of Tier 1 Capital (i.e. Treasurys) as well as other fixed income exotica, there are obviously limits to that relationship.

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Leftback
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December 9, 2016 at 4:09 PM ×

Returning to Dr Aghi, there is the old argument whether it is the (extrapolated) stock of bonds on the ECB balance sheet that is important or the flow of liquidity (i.e. the rate of the purchases). If you believe that it is ONLY the flow that matters (and this is a reasonable argument, b/c once the bonds are on the ECB balance sheet the liquidity is essentially frozen and disappears, hence no hyperinflation, right?), then yesterday's announcement in fact represents tapering of the program.

Think about it. The RATES that matter are the rates of ECB bond purchases versus the RATE of FOMC tightening. Both of these rates are currently being over-estimated in the one-way USD rally; perhaps Dame Janet will remind us of this next week.

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Macro Man
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December 9, 2016 at 4:20 PM ×

Actually, that's wrong. It ignores the rate of purchases relative to the outstanding amounts (which have been very significantly decreased), as well as the options for lending the securities back out into the market, which the ECB does.

A "taper" implies a reduction in pace with an endpoint in mind. The Fed's initial taper statement suggested further reductions in the offing. ECB did no such thing; quite the contrary- no endpoint suggested (given Draghi rhetoric) and an symmetric possibility to increase.

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Maverick
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December 9, 2016 at 4:47 PM ×

@washedup 3:48: Yes, indeed. It's probably more a case that bank stock performance has coincided and been supported by a steepening curve. Also, maybe Brexit gave markets a distraction (they can only focus on one thing at a time, goes the mantra) allowing some of the speculative bank shorts to vacate and try something else. Plus, subsequent to the vote, the economic data out of the EZ and the UK surprised to the upside, which, reinforced by steepening curves, led more to believe there was value in European banks.

To add to the mix, bank lending growth has accelerated in 2016 - after years of contraction and only a modicum of growth in 2015 - so marginal improvements to economic prospects (and curve steepening) have more of an impact compared to before. The ECB's TLTROs playing no small part, of course.

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Falco
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December 9, 2016 at 6:07 PM ×

Thanks for the comment MM. I support the idea that Draghi comments were dovish. Only worry is that the market might try to test the ECB on their reaction function in getting back to 80bln from 60bln. Btw, impressed by equity performance, seems to be no stop! Here a quick link to a post on the italian political situation. Apologies if it appears as spam. I hope it can be somehow useful. https://www.linkedin.com/pulse/three-scenarios-post-referendum-italy-markets-riccardo-pellegrin?trk=hp-feed-article-title-publish

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johno
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December 9, 2016 at 6:18 PM ×

Taper, reduction, semantics. The ECB reduced its pace despite core inflation sitting at 0.8% and 2019 projections still below target. To me, it suggests some unease with QE, that there are costs/risks associated with it. The reduced pace means less duration getting taken out of global rates markets. So a quantity effect. On the other hand, a price effect in Europe from the removal of the depot floor. Verdict of the market: duration bearish.

Yellen next week is the possible catalyst for a turn in fixed income and the dollar, I think. If she doesn't turn bonds, then I don't see why they won't keep selling off until they precipitate risk-off in equities. That may end up being the end-point of the bond selloff. I wouldn't be surprised to see bonds bounce here (positioned small this way, currently) ... we're close to the lows and you have dove Yellen coming right at you (and who sells bonds at new lows going into that, especially when everyone is short? If anything people should be taking some profits here). The interesting thing is going to be to see how bonds trade after Yellen. If they're weak, I'd be inclined to push it and go short.

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washedup
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December 9, 2016 at 6:43 PM ×

Whatever TF Draghi was trying to accomplish, clearly all he did was confuse people. Haven't seen this kind of head scratching since the Greenspan days.
Johno completely in agreement re: bonds - I think the mean reversionistas are about to be very disappointed (sorry LB) unless they can turn equities around, and not by a little bit either given recent correlations. I almost dipped my toe in TLT at 119 and feeling glad I didn't - may try again at the summer 15 lows around 115 with a tight stop, but feels increasingly like a massive rip your face off move into Jan/Feb.

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Anonymous
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December 9, 2016 at 7:03 PM ×

how important is the synchronized uptick in global pmi's since q3 to this global steepening/infl expectations trend?



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CV
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December 9, 2016 at 7:33 PM ×

For the record, I completely agree with MM's assessment of the ECB here. But I have a way for everyone to be friends on the euro too. In short, I think the Fed matters much more for the Euro and indeed global bond markets than the ECB. In this sense, I agree with LB that the Trump/reflation/steepener trade could get blindsided soon ... but I think it is the Fed that might do it. I.e. a dovish hike of some sort.

The reason I think yesterday was potentially very significant essentially is this by MM;

"The Fed's initial taper statement suggested further reductions in the offing. ECB did no such thing; quite the contrary- no endpoint suggested (given Draghi rhetoric) and an symmetric possibility to increase."

So forget about the flow for a minute, and ask yourself the following question. Can you come up with a forecast for 2017/18 in which the ECB shelves QE completely, i.e. signals tapering a la the Fed? I could I suppose ... but I really struggle!

As for the euro, it has proven very heavy sailing for the bears below 1.05 ... maybe it needs a Le Pen/Wilders jolt to get there. But you have to say that the way front-end U.S/German spreads are trending ... the onus is on Yellen here to step back from the hikes if she does not like to see DXY go up too fast.

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checkmate
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December 9, 2016 at 7:43 PM ×

The ECB is constrained as much politically as it is economically. EU elections throughout the 2017 year with the downside risk of ongoing Brexit negotiations present for up to two years. They are going to need some overpoweringly good news before they sign off on QE.

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Anonymous
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December 9, 2016 at 7:57 PM ×

Spoos melting up again for the 5th day in a row. Margin call for Nico...

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Nico G
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December 9, 2016 at 8:19 PM ×

i wish you existed

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Anonymous
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December 9, 2016 at 8:26 PM ×

pretty good summary of things from the equities side -

http://www.zerohedge.com/news/2016-12-09/rbc-answers-question-every-investor-asking-what-could-derail-rally

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Mr. T
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December 9, 2016 at 8:26 PM ×

I'm not making a bet either way (yet), but this rally strikes me as totally bogus. It started with positioning post election, now the street is backing price into rationalizations {reflation/maga/deregulation} while ignoring all negative policy implications (trade barriers, pissing off our partners, policy confusion, etc).

If the market had stayed down post election, the narrative would be completely different.

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Anonymous
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December 9, 2016 at 9:15 PM ×

The Dow, S&P, and Nasdaq closed higher every day this week for the first time in 5 years

Bears must be loving this rofl

PS (Spoos still rising on CME post-NYSE close)

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Anonymous
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December 9, 2016 at 9:18 PM ×

I can't believe how wrong all the macro guys are getting these moves: betting on equities falling, and USD down... and guess what? We get the exact opposite ! This site is the best contrarian indicator around !!!

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DoomsDay
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December 9, 2016 at 9:23 PM ×

Hmmm you guys need to read this:
http://www.zerohedge.com/news/2016-12-09/top-hedge-funds-predict-how-it-all-will-end

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Shoeless
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December 9, 2016 at 9:25 PM ×

Anon @9:18

You have a very small universe of Macro funds to look at in your basement, I imagine. The discretionary FoF portfolio I run has handled the turn better than any time in the past five years. The book was up in November and is up in December, with some equity long exposure, but we all know that Macro bread and butter has always been rates and FX. 80% of the VaR is in these two asset classes and performing quite well.

Now run along - I think your Spaghettio's are ready. If you are lucky, your mom got the type with the meatballs.

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johno
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December 9, 2016 at 9:42 PM ×

Mr. T @ 8:26pm, you know what else sounded totally bogus? Abenomics in November of 2012. Four years later, no inflation, disappointing reforms, poor growth, and still markets haven't called bull sh1t. Beware Trumponomics.

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abee crombie
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December 10, 2016 at 3:33 AM ×

I'm getting the impression if euro breaks out it will give markets free pass to push on recent trends. Strong U.S. Dollar, higher rates, higher equities in developed world. But that is almost a no brainier unsustainable position. Higher rates gonna pinch at some point. They always do. We're not gonna get an inverted yield curve with these new central bankers. So old rules will need to adapt. Now the question is on timing the whole darn thing as well .. Francois Trahan still beating bear drum on fairly similar argument.

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koolbong
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December 10, 2016 at 10:03 AM ×

@johno... I do think that's an unfair comparision... Abenomics was Japan's first real attempt to do something different, and they did try to be 'credibly irresponsible' (forget the exact turn of phrase, but something similar was the remedy suggested by Bernanke way back)...

and for all it's lack of success on the inflation front, the country has seen corporate profit margins rising to record highs... if the third arrow (fiscal stimulus) had been fired, who knows it may have been an entirely different story altogether...

Trumponomics in contrast is too ambiguous to be called an economic plan... we will spend, we will impose tariff barriers, we will cut taxes... and somewhere in that process we will make America great again!...
appealing imagery - yes, definitely; economic plan - I guess not...

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Anonymous
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December 10, 2016 at 3:45 PM ×

IG/HY CDX moves this week:
73 → 67.5bps
383 → 356bps
Credit bears getting "nuked"; don't have to agree with "why", but it's happening
If you are one of them, the only place to hide with enough liquidity to get in is stocks. Not saying it's right or wrong. It simply is.

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johno
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December 10, 2016 at 5:51 PM ×

Hi koolbong @10:03, point taken on Japanese margins, especially in the non-manufacturing sector, there's been a real breakout versus historical ranges. But on most other measures, I think Abenomics has been a disappointment to the optimists.

I think there are lots of things that Trump could reasonably improve. Regulation/complexity of rules for everyone but the tech sector is appalling. Corporate tax rates are highest in the OECD (or second highest? in any case, there's a reason the flow of corporate inversions is one-way). Infrastructure is way underinvested. The healthcare system is massively inefficient. There's lots of potential and probably more Trump can do with a Republican congress than Abe could do even with an LDP majority.

You mentioned taxes too. One thing I found interesting was Druckenmiller defending the whole Laffer Curve argument for tax cuts. Looking back at the data, it doesn't look like government revenue fell back when Reagan was cutting taxes, which surprised me because I'd always understood that those Laffer Curve arguments were "crank economics." So maybe there is something to tax cuts after all.

Anyway, I'm skeptical of the whole argument that we're going to have a repeat of the 80s for the simple reason that credit growth was explosive then whereas now we start from a position of over-indebtedness. But my point is, Trumponomics can eventually be seen as mostly a failure and yet Trump trades could work for years, as happened in Japan. Some things are likely to get fixed after all, just because there is so much wrong in the US currently.

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Anonymous
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December 11, 2016 at 8:47 PM ×

Why the Euro will not survive 2017:

http://www.davidmcwilliams.ie/2016/12/08/it-is-almost-certain-that-there-will-be-another-euro-crisis-in-2017

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koolbong
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December 12, 2016 at 5:27 AM ×

@johno... yes, I would agree with you that the trade can run for a while longer...
think the primary impetus comes from the Republican clean sweep, which basically means that for the first time in ages Washington will actually see some policymaking happen... is that worth ~100 bps in rates, ~5-8 pct in the DXY and ~10 pct in equities... I don't see why not, so am not in the fade the USD / UST move camp yet...
eventually though the 'quality' of that policy making will tell... and I suspect it will be weeks not years before the trade turns...

on the tax cuts... even before we get into Laffer Curve arguments (which I would concur are more freakonomics than economics)... I am generally sceptical of the demand-pull side of the story itself... sharply lower oil prices over the last couple of years have effectively been a tax cut... but any increased consumption has been more than offset by a combination of demographics, innovation and various other factors that we can only guess at...

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Nico G
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December 12, 2016 at 5:52 AM ×

Chinese equities are dealing with a bit of reality this morning

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