Two things have become clear, thanks to the slightly spicy English of Mario Draghi. To set the stage, it’s October 26th, 2017, and we wait for the latest announcement from the ECB. US 10s are near recent high yields, breaching the tough resistance of 2.40%. The Euro has come off the boil, and stocks everywhere are near the highs. Out comes the text, and Mario does not disappoint, hitting all his lines right on cue. Rates will remain low; however, the ECB will slow down asset purchases, in a measured way, starting next year. Then comes the press conference, and he confidently walks it back. Yes, the economy is doing well, but if we don’t see some inflation, we are fully prepared to hit the gas again. Boom. Bonds and Bunds rally, rates fall, Euro gets creamed, stocks take off. And the two things are….
Two years ago, Dudley was spooked by tightening financial conditions. Now, they can’t figure out why they are so loose.
I think there is a simple explanation. Two years ago rates were so low that credit could not go any lower, as they would go below the default rate. So it looked like financial conditions tightened. Now, as the fed raises rates, credit has stayed at the same price, so it looks like financial conditions are getting looser. Here is a chart of auto loans. Rate has not changed. Unless the central banks buys credit (as they have done in Europe, forcing HY below UST), the nominal rate cannot go any lower, but won’t go up right away either. If you are at the default bond in credit, do measures of financial conditions fail to make sense?