Mario Draghi Extends Martial Law – ‘State Of Exception’ Is Permanent

Engineering a state of exception comes with considerable risk. The Fed (and central banks in general) carries an implicit responsibility for orderly reemancipation of the markets, which makes stimulus unwind especially tricky. This highlights the deep dichotomy of power: While a state of exception is an exercise of power, there is a clear tendency to disown that power. And the only way to avoid facing the underlying dilemma is to never give up the power. This creates a new status quo – a permanent state of exception.

In essence, it is all about diluting the possible downside of stimulus unwind – an attempt to have an option to obfuscate without losing one’s credibility. With traditional market rules and relationships breaking down, central banks appear to be chasing the illusive target, which means that victory and the final goal are not well defined, which in turn insures the persistence of the “battle” and indefinite continuation of the state of exception. This implies indefinite suspension of traditional market exchange, which means continuous uninterrupted exercise of power that must be won every day.

That’s from Deutsche Bank’s Aleksandar Kocic and I think it’s important to think about those passages in the context of what we’re seeing recently in terms of heightened tensions on the Korean peninsula and the rapidly deteriorating situation in American politics.

The problem with keeping crisis-era policies in place a decade on from the actual crisis is that if you wait around long enough, they’ll invariably be another crisis. Which means the state of market martial law will have to remain in place for even longer. Before you know it, what was “extraordinary” has become the norm. The “state of exception” has become “permanent.”

We’ve variously argued that the latest escalation in rhetoric between Washington and Pyongyang combined with the debt ceiling debate in the U.S. and Trump’s growing list of political problems will make it exceedingly difficult for the Fed and the ECB to move ahead with policy shifts in September. Simply put: getting aggressive about balance sheet normalization in the current environment risks adding fuel to the fire in terms of giving markets a reason to sell off.

Sure enough, this morning, we got this:

• DRAGHI IS SAID TO NOT DELIVER FRESH POLICY AT JACKSON HOLE:RTRS

Of course Reuters is the ECB’s go-to outlet when it comes to leaking policy trial balloons. Here are some excerpts:

European Central Bank President Mario Draghi will not deliver a new policy message at the U.S. Federal Reserve’s Jackson Hole conference, two sources familiar with the situation said, tempering expectations for the bank to start charting the course out of stimulus.

An ECB spokesman said that Draghi will focus on the theme of the symposium, fostering a dynamic global economy, in his Aug. 25 remarks, while the sources added that he was keen to hold off on the policy discussion until the autumn, as agreed at the last rate-setting meeting in July.

Expectations for the speech had been building in recent weeks with investors pointing to next Friday’s event as the likely kick off in the ECB’s debate how to recalibrate monetary policy given solid growth, rapidly falling unemployment but persistently weak underlying inflation.

In 2014, the last time Draghi spoke at Jackson Hole, considered the world’s top central banking get-together, he laid the foundations for the ECB’s quantitative easing scheme, also fuelling expectations for a major speech this year.

“Expectations that this will be a big monetary policy speech are wrong,” one of the sources said.

Yes, “expectations are wrong.” But the question is this: were expectations wrong?

That is, it seems pretty likely that Draghi was going to use Jackson Hole as a forum to telegraph that the ECB was indeed planning to start unwinding PSPP. You’d have to be dense to think that this new report has nothing at all to do with geopolitical developments or with the domestic turmoil in the U.S. 

This is quite clearly central banks starting to think about how they’re going to approach September in light of recent exogenous shocks to risk sentiment. Here’s what we saw in the euro:

Remember, Draghi’s upcoming Jackson Hole speech was one of the key drivers behind the euro’s furious rally and expectations for that speech helped fuel stretched spec positioning on the long side.

But again, central banks are now stuck. They can’t lift martial law and allow markets to start functioning normally at a time when the landscape is littered with land mines and risk-off catalysts.

Ironically, the longer they wait, the more vulnerable the market becomes. The longer the state of exception remains in place, the more entrenched becomes the hunt for yield and the excessive valuations that hunt creates. And perhaps most importantly, the permanent suspension of the rules allows the short vol. feedback loop to become more deeply embedded into market microstructure.

So when you think about the Reuters Draghi piece linked above, think about it in those terms – it’s more important than it seems.

Additionally, don’t forget that the longer they wait, the more likely it is that they are going to end up staring down the next crisis with rates still hugging the lower bound. Which brings us directly back to what we said on Tuesday evening about the value of negative-yielding debt having risen back above $8.5 trillion:

Where are rates going to go if central banks have to ease to combat the next downturn?

More poignantly: have we passed the point of no return in terms of escaping from NIRP?

And if so, how far into negative territory can central banks push rates? Further, what are the consequences in terms of supercharging the hunt for yield even more than it’s already been supercharged? How big will the risk asset bubbles get?

Again: it’s Kocic’s “permanent state of exception.”