Long Straddle Definition and Strategies
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One of the fundamental questions of literary analysis is whether the reader can understand the message the author’s trying to convey and typically the key to decoding these message is knowing who the author was. Hopefully we’ll be able to apply that same principle to the European Central Bank’s (ECB) puzzling statements after its January meeting. The institute plays a defining role in the European Union’s interest rate and monetary policy so their words cannot be taken lightly.
The answers Benoit Coeure, member of the ECB executive board, gave reporters after the meeting could certainly be seen as ripe with literary ambiguity. Not necessarily a positive trait for a central banker. Monsieur Coeure has spent many years working as the Deputy Director General of the French Treasury and today he’s considered the most obvious candidate to succeed Mario Draghi, the sitting President of the ECB. When asked during the press release about whether the ECB will raise interest rates in 2019 he responded with “it’s too early to have that discussion because we’re still understanding the nature of the shock.” What shock was he talking about? Is there some kind of crisis going on under our noses that we’ve failed to notice and one that not even such a qualified and experienced financial professional can understand?
Every central banker worth their salt should be able to come up with a quick response to that question, but the word “shock” should rarely come up in that context. Not to mention that he went on to say he didn’t have enough information about it. The answer he gave is definitely one that needs to be unpacked.
Let’s go back to the question of what shock he could be referring to. He could’ve meant Brexit of course, since it’s a phenomenon that has left many baffled. That said the Brexit situation merits uncertainty more than it does shock, so we can likely exclude it from the list of suspects. He could’ve been referring to the EU’s slowing GDP growth in 2018. It went from 2.7% in Q1 to 1.6% in Q4 with analysts expecting it to decline further as low as 1.2-1.5% approximately. This drop was attributed to halting the ECB’s quantitative easing program the same year. Hardly a shocking outcome. The gradual tightening of the money supply slowly lowered the banks’ capital reserves. This negatively affected the GDP growth of every member state which is consistent with the ECB’s reasoning for ending their QA program in the program. The original rationale behind ending it was to slow down Europe’s allegedly overheated economy. That position is somewhat difficult to justify shortly after the Brussels administration restricted the sale and manufacturing of certain German automobiles following a recent emissions scandal. This is often used as the explanation for Germany’s recession. If the slowing GDP growth is a consequence of the ECB’s measures, then they themselves would certainly not be surprised by it, so we can exclude that as well.
The only likely option left is inflation and inflation trends over the previous year have undoubtedly gone against the ECB’s expectations. The defining tendency of 2018 was the euro weakening against the US dollar which should have caused prices to increase in the highly import dependent European Union. The reason that didn’t happen was actually President Trump’s trade war resulting in commodity and resource prices going down due to shrinking demand projections. This countered the inflation-inducing effects of the weakening euro.
Slowing GDP growth, low inflation and a weak currency. It almost seems like a mirror image of the problems The Bank of Japan was facing 10 years ago. Increasingly conservative consumer behavior puts a cap on the domestic market and forces them to focus on exports, thus making their economy more exposed. There’s no shortage of issues one can find in Europe including demographic problems, migration, the 2019 European Parliament Elections and yet all of them are slow-rolling crises that the ECB has had ample time to study. Among these many dilemmas, which one could have possibly shocked Monsieur Coeure?