Ray Dalio – The Problem Is With The Markets: Not With Mario Draghi’s Policies

Written by Ray Dalio, LinkedIn

Market participants and markets have shown themselves to be erratic while Mario Draghi and the ECB have shown themselves and their policies to be steadily in the right direction. As a result, it has been the norm for markets to swing to extremes on both sides of the trend (which has been shaped by ECB policies). Thursday’s reaction to Draghi’s announcement was one of these.

Concerning the recent erratic market action, it swings with erratic swings in sentiment. The market was very short the euro and very over-weight European equities, so it was primed for a correction. See the below charts which convey that.

There is a saying in the markets to “buy on the rumor and sell on the news”. That’s what happened. There was a lot of buying of dollars (shorting of euros) on the rumor that there would be more aggressive movement by the ECB. There was going to be selling on practically any announcement. So, the markets’ reactions reflected more about the positioning and erratic behavior of players than the inappropriateness of ECB monetary policy.

Draghi has taken, and will continue to take, adequate actions to reach the 2% inflation target. We expect that he will do that in an orderly and measured way, which is appropriate, all things considered. He is operating in a political system that pressures him from both sides – both from = those that say that he is moving too far and too fast (most notably conservative Germans) and from those who have wanted him to move much faster (which we are in the camp of). But he has proven to have balanced these pressures in order to do what’s necessary when it’s necessary. At all key moments, he has done the right things and the whole world is better off because of it. By now the world should know, don’t fade Mario Draghi.

Thursday, the market essentially bet that he would not move adequately. Yet, the more the market discounts that Draghi will move inadequately (e.g the more the euro goes up and the stock market goes down) the more that it is likely the ECB will move at an accelerated pace and prove the market wrong. That is because Draghi and the body of those in the ECB who shape policy with him understand how the economic machine works. They understand that the degree of tightness of monetary policy is influenced by a) interest rate movements, b) QE movements (and related macro prudential policies) and c) currency movements. With interest rates unable to move meaningfully, QE and currency movements matter most. Clearly there needs to be more easing and clearly the more the currency rises, the more (and more forceful in completion) the QE needs to be.