Heisenberg Report

Mario Draghi Might Need To Chin-Check ‘Someone Else’ And By ‘Someone Else’ He Definitely Means Steve Mnuchin

I was only half joking when I suggested in my exceedingly profane Twitter feed that in light of recent events, we might have an “on sight” situation on our hands the next time Mario Draghi ends up in the same room with fellow Goldman alumni Steve Mnuchin.

The problem with being a central banker in a world operating under a competitive easing regime is that when all of your accommodation finally “works”, the market immediately acknowledges your “success” by driving up your currency. So if, after years of persisting in accommodative policy, you manage to engineer robust growth and more importantly, if you start to see inflation move decisively towards your target, the market takes that to mean you’re likely to ease up on the easing (so to speak) and as soon as the market thinks that, well then your currency starts to appreciate.

The calculus for market participants revolves around perceptions of policy divergence, relative economic strength and how far along you are in hitting your inflation target. Invariably, the global push towards normalization will not be anywhere near as coordinated as the plunge into accommodation was (recoveries will be uneven from economy to economy). So, the “winners” get unwanted FX strength commensurate with how far the market believes they are towards hitting their goals relative to everyone else and the reason that FX strength is “unwanted” is precisely because if it gets too acute, it has the potential to undermine the very progress on growth and inflation that made you the “winner” in the first place. That’s the “policymaker paradox”.


2017 began with a policy divergence narrative between the U.S. and Europe. Draghi was starting from behind (still expanding the balance sheet and rate hikes years away) and the EU faced a number of potential stumbling blocks on the political front that, in the worst case scenario, could have stoked fears of a breakup. Meanwhile, the Fed was moving ahead with rate hikes and everyone assumed the Trump agenda would underpin the U.S. reflation narrative, driving up yields and supporting the dollar. That, in short, is why “long USD” and “short USTs” were the two “no-brainer” trades headed into 2017.

Well needless to say, that didn’t play out.

Europe cleared its political hurdles (Marine Le Pen was trounced in the French elections and Geert Wilders fizzled out), posted decent economic numbers and then, in late June at a policymaker gathering in Sintra, Draghi suggested he would be willing to look through “transitory” downward pressure on inflation.

Meanwhile, the Trump administration was mired in the Russia investigation and the failure to “repeal and replace” underscored the notion that the rest of the President’s agenda (including and especially the tax cuts) would be far more difficult to implement than anticipated. All the while, persistently disappointing inflation prints undermined the case for an overly hawkish Fed.

The result: the policy divergence narrative transformed into a policy convergence narrative between the U.S. and Europe and ultimately, the euro had its best year against the dollar since 2003.

The euro’s rally has continued in the new year, riding a number of fresh catalysts including (more) upbeat data, hawkish minutes from the ECB’s December meeting, news that China may be set to diversify further away from USD assets and rampant speculation that Draghi will call an end to APP in September (as opposed to extending it through the end of the year).

The ECB was willing to stomach euro strength tied to those factors, but what they are not apparently prepared to take lying down is Steve Mnuchin supercharging the euro rally by showing up in Davos and immediately jawboning the already weak dollar lower still, which is exactly what he did on Wednesday. Here’s an annotated visual to give you an idea of how this situation has evolved:

Again, the timing couldn’t have been worse for the ECB. They were already dealing with a rapidly appreciating euro and extreme one-sided positioning. Mnuchin’s comments in Davos suggested that managing that euro appreciation without explicitly calling for an extension of QE into at least December 2018 could end up being an exercise in abject futility. You can’t finesse the message when you’ve got the U.S. Treasury Secretary openly calling for a weaker dollar to boost trade. The only way to counteract that if you’re Draghi is to bust out the bazooka which, again, would entail doing something wholly dramatic.

So this was the setup going into Thursday’s post-ECB meeting press conference. Everyone was watching this closely to see if Draghi would attempt to verbally intervene and had Mnuchin not done what Mnuchin did, the following comment probably would have been enough to arrest the euro rally and maybe catch some of the crowded longs offsides:

Again, under normal circumstances, that would have sufficed, but that isn’t even close to the kind of aggressive stance he would have needed to muster to counter Mnuchin. And so, we got this:

That was the reaction to Draghi expressing concern about the stronger euro. Just imagine if he hadn’t said anything at all. What that chart shows for any of you who aren’t FX traders is that the market was not at all impressed with Draghi’s “response” to Mnuchin.

Of course Mario knew this would be an exercise in futility going in. What happened here is that he was blindsided by how overt Mnuchin was and he didn’t have time between Wednesday and Thursday to figure out how to best to counter it.

So do you know what he did instead? Well, I’ll tell you. The big homie Mario verbally chin-checked Mnuchin with the following series of remarks which are wildly out of step with anything that even approximates decorum:

The exchange rate has moved in part because of endogenous reasons [but] in part due to exogenous reasons that have to do with communication.

But not by the ECB, by someone else.

This someone else’s communication doesn’t comply with the agreed terms of references.

That “someone else” is the little homie Steve Mnuchin and also Mnuchin’s orange clown boss.

Just to be clear, there is exactly zero chance that Mario Draghi is going to sit idly by while Donald Trump and Steve Mnuchin effectively work to negate the impact of the ECB’s years-long effort to boost the European economy and get inflation back to target.

I don’t pretend to know what Mario intends to do to “fix” this situation, but again, whatever the non-hood equivalent of “on sight” is, you can expect to witness it the next time Draghi is in the same place at the same time with anybody from the Trump administration.