“Tricky” Trichet Whipsaws the Euro
by Gary Dorsch, Global Money Trends. December 27, 2007
European Central Bank chief Jean "Tricky" Trichet gets his nickname "Tricky" from spinning traders in circles, saying something one day, then doing the opposite the next day. After flooding the Euro-zone money markets with an unprecedented 350 billion euros of cheap cash on Tuesday, the ECB began quietly mopping up the surplus funds by Friday. "We are not pouring in liquidity," – ECB chief Jean "Tricky" Trichet told the European Parliament in Brussels. "The loans are paid back too."
Last week, inter-bank Euro lending rates fell after the ECB's biggest ever single cash injection, a two-week operation, aimed at insuring banks would have enough liquidity though year-end. One month Euro Libor interest rates plunged 50 basis points to 4.45%, the biggest drop in almost six years.
However, the ECB disclosed over the weekend that it had already drained the excessive liquidity over the next three days, Wed – Friday, by withdrawing 420 billion euros, substantially more than the 350 billion euro injection it made on Dec 18th. Austrian central banker Klaus Liebscher insisted the ECB would do everything necessary to reduce Euro zone inflation, which reached a peak of 3.1% last month, well above the bank's upper target limit of 2%.
Following the disclosure about the ECB's aggressive draining action, the Euro rebounded to $1.4615 in thin holiday dealings from $1.4350 on Friday. "Tricky" Trichet is famous for whipsawing traders in the FX market. But for most of 2007, the Euro closely tracked interest rate differentials between the German 2-year schatz and US Treasury 2-year notes. Since mid-August, German 2-year yields have climbed to +80 basis points above the US 2-year yield, up from zero percent in mid-October, lifting the Euro to a record $1.4966 on Nov 23.
The Euro's historic rally did hit a brick wall when "Tricky" Trichet warned on Nov 26th, "Sharp and abrupt moves in the Euro exchange rate are not welcome from the standpoint of economic growth, and I do not welcome brutal moves," (code words for intervention last used in Dec 2004). Trichet noted that US Treasury chief Henry Paulson said a strong US$ was in the best interest of the United States. "I noted with great, great attention that declaration," Trichet warned.
Over the next four weeks, FX traders obeyed Trichet's orders, and dumped the Euro to as low as $1.4315 last week, even though German 2-year yields remain firmly anchored in the Euro's favor at +80 basis points above US T-notes. On Dec 14th, the Euro plunged 2 US-cents to $1.4415, its largest daily loss in three years, after US Labor apparatchiks reported the US consumer inflation rate soared to 4.3% in November, lowering the odds of a Fed rate cut next month.
However, the Bernanke Fed is more concerned about bailing out its shareholders, - Wall Street brokers and banks, from the sub-prime mortgage meltdown, and is expanding the US M3 money supply at a 16% annual rate. President George W. Bush said on Dec 20th he would consider all options to help the US economy weather a deep housing slump, and the easiest and quickest option is to pressure his appointed lackeys at the Fed for an easier money policy in January.
If correct, the US Federal Reserve is still on course to lower the fed funds rate to 4.00% on Jan 30th, which could weaken the dollar. On the flip side, the ECB's sudden reversal, to drain 420 billion of excess liquidity, put a floor under the Euro at $1.4350. Still, Trichet's erratic handling of the money spigots has already led to unintended consequences, lifting North Sea Brent oil to all-time highs.
North Sea Brent oil prices in euro terms surged to an all-time high today, exerting upward pressure on Euro zone inflation. The European Central Bank has been monetizing the soaring cost of energy for the past three-years by inflating its Euro M3 money supply to a 12.3% annual rate. That's five times faster than the growth rate of the Euro zone economy, and is stoking higher inflation.
Under the leadership of Jean "Tricky" Trichet, the ECB has veered far away from its monetarist roots and the original 4.5% growth target for Euro M3, deemed the maximum growth rate for stable inflation. Nobel economist Milton Freidman once remarked, "Central bankers always try to avoid their last big mistake. So every time there's the threat of a contraction in the economy, they'll over stimulate the economy, by printing too much money. The result will be a rising roller coaster of inflation, with each high and low being higher than the preceding one," he warned.
Traders must be flexible and nimble when dealing with "Tricky" Trichet. Stealth operations in the money markets by central bankers are difficult to uncover in the $3.2 trillion per day market. Thus, FX traders tend to rely heavily on chart patterns and the behavior of currency prices, to confirm their suspicions about covert central bank intervention, or interpretations of news that influences market psychology.
© 2007 Gary Dorsch