Surveillance: Mario Draghi's ECB Legacy

time gone? Let's talk about this market? Shaw We three am, cutting forecast, CAT cutting forecast, Texas instruments, cutting forecasts, the market getting a ton thrown at it and it's holding up really well to discuss. Kate more black Rock Global Allocation Investment teamhead of Thematic Strategy. Good monitor, Kate, good morning. Sometimes the information content in how a market response to data can be just as important as the data it's self.

That's right. The last couple of days, did they speak to that? Yeah? I think that's right. So there's there's one way to think about investing, which is it's not good enough to have the right information or what you perceive to be the right information. It's not good enough even to think about or think you have a view on what consensus thinks to write information is you also have to get to that third degree, what does consensus think consensus things? And I think this is what's really

critically important. Consensus thought, consensus though things were gonna get a lot worse. And uh, we're at a place now where maybe on some of the industrial companies we're not seeing a meaningful pickup and activity, but this pace of deceleration has slowed, and there are signs of life and actually some words us like optimistic and optimism across a number of the cyclical sectors that are leading people to think that, you know, fourth quarter, maybe first quarter of

are going to be the cyclical low. And I think that's leading these people who have been positioned for you know, a prolonged slowdown, perhaps even a recession, to take to take on some of these cyclical companies. Again, well, let's take this morning as an example. Eurostocks holding up really quite well even after another round of disappointing p M I S. A lot of people might be saying, we've seen the worst of it. Are you confident we have now?

And the eurostox is a great example actually because if you think about this, the back the macro backdrop is still really weak. We have not actually gotten past that point of decelerating growth. The fundamental story for a lot of the European companies, particularly domestics, don't look exceptionally strong valuations. It's hard to argue they're cheap, especially when you think about the companies that are producing growth and the premium

they're trading to the rest of the market. But you know, this really comes back to the sentiment where a lot of people had not owned European stocks for a while. We had seen consistent outflows across all European managed funds as well as et f s, and there's a little bit of a catch up the promise that maybe there's some fiscal stimulus, maybe there's going to be uh, some signs of life, and the markets outperformed. I'm not sure

that our performance is sustainable. John, what Charles Cantor said, Uh, with new Bigger Berman. It's idiosyncratic. Now there's Twitter cratering down off uh, you know, lowest levels in April and off quarterly sales disappointment, etcetera, etcetera. We're all buried in the idiosyncratic Now for mere mortal investors just trying to make the retirement plan go up. Do you take a bigger,

broader view and just ignore the idiosyncratic. I think you've made a good point, though, Tom, there are lots of very specific stories, not just in this earning season, but in terms of market leadership throughout the course of two thousand nineteen. The good news is especially I'd say the US large cap space has a large number of these strong idiosyncratic stories, and that's kind of what what gives the strength of the S ANDP. Have we ever been

more miserable John going up yere today? I don't think the scars of q Q is still so deep cake, and I think a lot of people are still worried about going into twenty leveled up adding some cyclicality to their portfolios without really seeing a bottoming out in the economic data. Talk to me about the spread right now between south side expectations and by side sentiment. Clearly not a precise science, but just how you interpret that at the moment. Yeah, I think there's a huge spread. Actually.

One of the easiest ways to gauge this is in terms of cash levels and overall defensive positionings on the Bye side relative to the cell side. Earnings expectations for the twelve month forward and you know, something John and I were just talking about was that if you look at this week last year, expectations for earnings over the next year, and that that cave two thousand nineteen, but

in this case or pretty much the same. This is another way to say the Cell side hasn't significantly adjust did their expectations yet, but the behavior on the Bye side in rotation and holding higher cash and slightly more defensive positioning um really doesn't square with what might have been decent numbers for earnings that are in the south

side forecast. I think people have been scared. There's been the geopolitics, there's policy, there's the growth data, and they're very, very concerned that the duration of this cycle is too long. In Black Rock, what's the percentage of people that have enjoyed this bullmarket? Has this been the all time loneliest up of the last one year or two years? Percentage of people who have enjoyed it in or you know, you know, I get the feeling it's actually pretty lonely.

There's a lot of people, because of these idiosyncratic geopolitical corporate stories, have just said no, are they're not in fully Yeah, they even when you are invested. I think the anxiety level and the fear that something could really reverse the mark it is much higher than it has been in any of the post crisis period. You know, that doesn't make the sleep quality of many of our

investors particularly high. Okay, what have people been buying? They've have been rewarding the companies with structural growth tail winds. Morgan Stanley have a take on this this week. They say the narrative of slowing growth has become obvious. The market has been rewarding companies with structural growth tail winds, betting they could grow through a slowdown. This has created valuation risks, and the valuation risks around say the software companies,

et cetera. Where do you stand on the area of the market right now? Yeah, Look, there are some pockets of the market. Software is an obvious example where valuations had become quite extended. Uh, and we're actually revenue revenue growth was not going to really come through, uh, not even just at the back end of but the chances

of it coming through were down as well. This is what I will say, though, UM, I think the call to rotate out of the more UH secular growth stories is far too soon in order to get very value oriented place, and this the sort of cyclical losers. To outperform, you need an acceleration in global growth. We're not looking for that right now. What do I want to pay for a small company that has revenues up? That's a big number, huge number. It's Microsoft, Okay, I mean I

get it. They're trading in a like John, you just said they're fully valued, right, I didn't say that. But but what am I going to pay for double digit revenue growth? And the answer in this environment a lot, right. And it's not even just the revenue growth number. It's the consistency of the revenue growth, the stability and existent the consistence and stability of revenue growth, the constant delivery.

You know, in a case like Microsoft, you have both a you know, annuity like business with a growth business. Excellent management. We got another three hours with it, right, You've got more minute, so quickly here let's go physics. Here. The market values a inertial force of good things. When you're at the zero bound, when you've got potential g d P under two. The value of that inertial force of good companies it's it's like the it's like it's unbelievable.

And this is why I don't really buy into that value supercyclical rotation to there's still a lot of uncertainty out there, you know, around the US election, around the schism between US and China, uh, the trade implications for a lot of different companies and industries, and there's a

lot of other geopolitical risk. You take all of this stuff together and you say, you, now, why would I step away from these companies that are consistently delivering, whose products, whose services, and whose management teams are best in class? So you know, my view is that we have to be thoughtful around valuation, but you can't let valuation lead and when you're making a decision at this point in the cycle, Okay, more great to say, you're fantastic to

have you with us in the studio. More of lank Rock. We want to give you context and we can do that from without question, the most emotional book on the Euro I have ever seen. It was written five years ago. His negotiations for the movie rights were so tenuous. We're looking for the fall of the Euro. Memorial Day two thousand twenty two, John but, a gentleman from Denmark, wrote a piercingly passionate book on the euro and on reinventing the Eurozone. In chapter by chapter, he went through, what

a god awful mess it was five years ago. This is the perfect guy to talk to about dragging. Give that for the book launch one I was party was three people. You know, I just you know. I didn't talk to him and I didn't get invite. He was so large I couldn't even talk to him. Aout the party, walked away from the moora set up his own shop, just picked up three books and left data founder and see how good morning to ends. Good morning. I don't know quite what to say, but anyway, thanks for the intro.

And here's what I'll say, when's the next book? It was so good? When's the next book? Writing a book takes a little bit of time, so I have to get approved for my wife before I'm allowed to write a second one. Eight years he's up ends eleven president drunk, he takes over the ECB. Eight years later he steps down. What's his legacy? So um he everybody says he saved the euro He did have a very important contribution to

ending the euro crisis. He had a very important contribution to sort of breaking new ground for the e c B. Right, we had the Mastric Treaty. It was supposed to be not legal for the ECB to buy any government bonds, and that he made it llegal essentially, not without it didn't change the legal text, but the interpretation of the legal text is totally different now. And I think if we can think about in very concrete terms, like think about Italy, over the last few years, we've had tremendous

political uncertainty. That was the main point in my book that the next crisis was going to come from political uncertainty. Right, and despite of that uncertainty, because there's such a belief that the ECB is there to provide back stuff, we had limited tension financial markets in Italy. We clearly had big moves up and down on btbs, but it never turned into like a financial crisis dynamic. And that's because of the changes drug you have done. That's his legacy.

Trech Let the red redenomination genie out of the bottle. Can we ever get it back in? So it all comes down to whether there's public support for the Euro. So if you go and look at opinion polls, it's actually pretty striking that we have all this pessimist about growth in the Eurozone, all the troubles that exist in the EU with Brexit and so forth, and then you ask people on the ground, do you want to keep

the Euro? In every single country support for the Euro is high, and in many countries at a record high. Obviously in Italy support is lower than other countries, but support is going up again. So it is quite interesting, giving all the pessimism that is out there, that the Euro is kind of light. Part of your wonderful ability here is to figure out the legacy of all these people. You do this out of our house. Your academics in Denmark. Drogg is m I t. Drog Is fundamentally is twisted

Anglo Saxon Field. Do they revert back to a Triche Deuisenberg Old World ethos or is he permanently changed the theoretical structure of historical Europe versus a more British or more American economics. Well, I thank that is a big question.

And I think one of the reasons why we had such a controversial decision at the last meeting was that Dragon wanted to set the tone for the next four years as well, and he has done so with the four guidance, where they essentially say they're not gonna raise interest rates until actual inflation, not just what the ECB staff is forecasting, but actual inflation is getting to the target.

It's quite an extraordinary form of four guidance, Johnny, you know I'll say this, and you know, maybe wrong, John, But the most thunderous moment as headline the next number of years was that single headline two years ago, we're dragging began to put a timeline on we're not raising race. Remember that he said, like, we're not raising race till the summer of nineteen or whatever. He pushed the limits

of Monechy policy. And yes, I think the criticism will be that an argument of his for quite a while is that for rates to behind the future, they need to be low. Now been negative for five years. And I think the debate, even after he leaves the ECB today will be whether any of this stuff actually works, Has que work? Does negative rates actually work? Is he taking it too far? Has he taken it too far?

The jury is still out, isn't it. So I think there's two aspects of this that you need to separate. So I think there's a financial stability argument. The Euros song was incredibly vulnerable to financial crises before we learned that the ECB was willing to buy sovereign bonds. That part of legacy, I don't think you can doubt. The other part of legacy pertains to inflation, and there it's a much tougher thing to to to sell that. He

has been very successful. You can look at where core inflation is now after essentially maxing out monetary policy, and we're close to one percent. We should be close to two percent, right, So I think he's been incredibly successful in terms of reducing the risk of financial crisis. He has not been particularly successful in terms of getting inflation

and inflation expectation up to the target. The way I've told that story essentially is by saying the first half of his tenure underlined the power of the ECB, the second half highlighted its limitations. Let's push things on, President Leguard. She's got a tough ask a lot of people, especially on this side of the Atlantic, and I find it

really interesting. I don't know what your conversations have been like with clients, he ends, but many people on this side of the Atlantic seem to believe that a president Leguard can get European politicians to do something that Mario Dragon could not, and that's if you have the fiscal space,

use it. Yeah, I think there's this perception that she was in charge of fiscal policy in France and therefore she has some kind of magic power to make sure the coordination between the central banks and the fiscal authorities somehow gets much much better. I think it's a bit more complicated than that. We're negative interest rates in your book, they were not. They were not stunning. Yeah, that's just stunning.

It's hard to predict the future, isn't it. It's not only the future, but it's hard to predict a complete shattering of a theory. I mean, I don't know what your econ one on one book was in Denver, but in Denmark. But whether it's beg or it's it's it's during bush fish or stars or whatever, man Q whatever none of his folks were living is in those books?

Is it? Like? Um? Like? Even if you think about debt sustainability, right, so you have this situation where you think, okay, if you have no growth, eventually your debt dynamics will run out of control. But if you have negative rights, that's not obviously anymore either, right, So everything gets turned on its head quickly. Space So there is something going on in some European countries. There's something going on Holland,

there's something going on in France. What we're missing is a big shift in Germany, and they have constitutional limits. They need to find a different name for it. They need to call it climb an investment and get around the constitutional limits to get a big push going. That's really sort of the hope at the end of the tunnel is that we can find a new name for fiscal stimulus that can get around those constraints. You're a target one three right now, twelve months out come on tapes,

tapes recording. The key thing is global growth. If global growth and can recover a little bit, the dollar will be down and the euro will be meaningfully stronger. See how he did that. That's very small. That's decades of work. I didn't get a number. I didn't get a time. So I think about it. When did we have peak happy talk? Peak happy talk springen for global economy and for global market spring right before now I'm talking about

global markets and global economy, the synchronized growth. In two, you're a dollar peaked out. Stelling won forty as well. So if things start to pick up. I didn't do the exact math, but the drug ear is a sixteent appreciation. In Europe, we've had a massive move success. At one point they were fighting to get it down because it was too strong. Remember that they were good times, weren't the yins. When we're in and around one forty fighting, you're still talking to him. He didn't give us a

number or a date. What I'm trying to get him now? Please continue? We came from one thirty nine point seven before the negative rates started, and obviously we traded below one ten very recently, so it's a pretty meaningful move. So he's still looking past. Can you get from T minus one at the T plus one year? I still want to forecast. I think in our global growth recovery scenario, it's pretty easy to get the euro backup to watch one. Okay,

now we can move on, we can move forward. Yes, Nord, there can't say enough about the fall of the year right to do it for it per book. We can talk about someone that used to over see the market operations of the e c B. The man that in this position would typically be executing the monetary policy. Really pleased to say that. Francesco Pappadia joins us now former ECB Director General of Market Operations, overseeing market ops through to twelve at the ECB. Francesco, good morning, great to

have you with us on the program. Good morning to you. A big focus at the moment on what the ECB can and cannot buy and if they want to commit to twenty billion a month, open ended, where will they be looking. What are your thoughts on that at the moment, Francesco, I think that the latest information we have on this is that that they can go on for quite a while, quite a while, goold mean one more year, um. They would not a bump into the limits for the Germany,

which is of course the biggest, the biggest problem. So they do have the time to revise the thirty a limit if they would see the problem coming. There was a big debate a couple of years ago about would they go beyond corporate debt, would they start to buy equities? And that's wrapped up again. Francesco, I imagine that when you were at the ECB in twelve. When you're executing the securities market program, did you ever think they'll be

buying corporate debt, corporate paper? Well, that was not so far away, So I mean we had been buying something similar to corporate debt, which is covered bonds. Cover bonds are issued by banks, so they are a private kind of paper, and we did We did that. When it comes to new things, that they could buy more than equities, which is a bit odd, I think, I mean, the Japanese are doing it, but I think it would be more likely that they would buy bank loans even without securitization.

Bank loans are already in the collateral pool of e c B, and in a way, that's the only asset which is in the collateral pool that is not bought outright, So if I have to think of the new asset, I think of the bank loans. Francisco, How controversial would that be for the ECB to buy the loans of banks that they also have to regulate. Well, I think that that would be of an order of magnitude easier than buying bank bonds, because if you buy bank bowns,

you buy the credit of the bank. If you buy bank aloans, you buy the credit of the customer of the bank, I mean, not to borrow it. So I think it would be easier from from this point of view because you don't buy the credit of the bank. Francisco Papadia with us right now, folks, and we're just thrilled it could be with us. All you need to know with a seminal effort at the e c B

is Director General for Market Operations, Francisco. John and I could talk to you for an hour this morning about this linkage of Mr drog Mr Powell, Mr Carney into a nascent question about trust in the very short term market, just with a view from sixty feet. Every official John and I have spoken to, including Lawrence Cudlo of the White House and Bill Dudley, formerly with a New York Fed,

have said there's not a problem here. Is there a problem brewing, brewing or existent in that very short term overnight trust market. I don't see that as a pressing problem quite frankly, um I see the main problem in my view is that central banks are close to having exhausted that their ammunition unless they invent something new, which they could. But unless they do invent something new, the unconventional measures, in my view, out closed to having finished

their their effect activeness. So I don't see a problem of trust. Um, I see a problem of effectiveness if you wish the vectors. If you take a log chart where slope matters, folks, and you look at the build out of the balance sheets of the different major central banks, do you have confidence in the mathematics and calculation of

the appropriate level of assets at any given central bank? Well, I think that the mathematics of this, as you say, has changed a lot and keeps changing, because what used to be normal in two thousand and seven two thousand and eight is no longer normal, and there is no prospect that we will get back to normal. And the report story in the United States is very meaningful in this and throwing a lot of information for all central banks about the liquidity demand by by banks and these forces.

In a way to think again about this issue, Well, it's almost and I say there's with great respect for your public service, it's almost learned as you go. What are you learning as you go from the data? John Can, I say, day by day almost from the New York Fed What are we learning with each of these auctions and each of these processes well exactly that the we have in the United States, and but that applies to

Europe and Japan as well. I mean the level of reserves so that banks have with a central bank is a large multiple, but very large multiple of what it was before the crisis, and everybody thought that that was quite enough to satisfy the demand of liquidity by banks. I mean, what is happening in the ripple market. I've seen that the FED came in with even larger operations are just just today shows that we are not understanding exactly what is determining the demand for liquidity by banks.

We have a view that the regulation has something to do, uncertainty has something to do, but I don't think that we have a full view. So what we are learning is what is behind the liquidity demand of that Francesco, just a final question from me to wrap up this interview. You left the ECB shortly after President Dragon took over the presidency of the European Central Bank. A final word from you on his legacy. Well, I I I always have stressed and that there is small continuity. Then people

think between different presidents. For instance, I think that the difference between that drug entriche has been vastly exaggerated, and I find confirmation of this in the fact that that Driche recently came with a strong defense of a drug

drag CCP. So in thinking about the legacy of of of drug, I think one should see that on a line that in a way started with that Richette, that was the first one to take unconventional measures and continuing was developed by drugging more than any kind of rapture between the two. Let me just add that after having left the ECB, I'm now with Brugel as a senior fellows. As you said, I'm so sorry did not mention that earlier,

and you can blame me for that. Francesco Francesco Papa dea of Brugo and also formerly the ECB Director General of Market Operations. Always great to get Francisco's thoughts. I think the team has done a great job. Of this team surveillance is give you some drugging perspective, the history back that where we are now in the view forward. We've had two wonderful guests and John, now we do

it again with someone steeped in the Germanic ECB history. Yeah, the Austrian Central Bank experienced their experience at the ECB on the board as well. I'm really pleased to say that formerly of the e c B, Gertrude Trump our googlele joins us now on the prone from Florence. Gertrude, fantastic to have you with us. We've reflected on the legacy of President Drug. Let's talk about the task ahead for President Legard. What kind of e c B does

she inherit? I mean the ECB has in this first twenty years um at East a lot um overcome the financial crisis. I hope to recover the economy, but now the challenges to find the right moment for for an exit. At the moment the economy is slowing down, so therefore it's it's too earlier about to talk about an exit. But we bc that Mr Drug has achieved a lot recently more easily. There was motibate about the right policy mix.

I think the ECB will have a debate about the strategy the view of the surtity, and this is one of the first task of Mrs Lagard. Gertrude, what are the conditions that you would need to say that would be sufficient enough to follow through with the next sit The Japanese have talked about an exit for twenty years. What would you need to see in the European economy

to actually see that materialize? I would say solid growth rates UM, sufficient progress on UM, single markets, on banking union UH, and also UM, let's a readiness of the policy to contribute to solid economic growth. Gertrude, many people disagreed with the latest round of QUI. In fact, maybe the latest moves from President Drug his final act was perhaps one of the most controversial acts within the government council. Did you disagree with the latest round of QUEI? Is

that something you were against? Um? I'm no longer a member of the guvern now I understand that, Gertrude. Of course, fully I've introduced to formally off the e C baby your thoughts as they currently stand. Is that a decision that you disagree with? I mean you you need to have the full picture when you take these decisions. I think it is. It was very controversial to make an

additional UM, let's say rate cut. UM. I think it is. UM. Yeah, it's important to think about the stabilization of up rage and normalization of rage as soon as the as the economic situation allows it. We are not yet there. It will take time. But the negative consequences of of low interest rates are visible in the economy. You see it in the I would say, in there's asset prices. You see it in the UH. Savings plens. So there is um some fear and they in the in the public

also that the police is to lose. But I think for the time being there is no possibility to change it. But it's important to be aware of the negative side effects of the acommodative policy. Dtr tumplgo girl, Thank you so much for being with us today. Gertrude Than of Austria on the former vice governor of the Austrian Central Bank, and you hear there, John, something is somewhat unfamiliar to American listeners. There's that Germanic that we associate with Axel Weber,

Akmark is sing with Temple Google. They have a decidedly different view than many of the twenties seven yea. More recently, the former governor of the Austrian Central Bank as well, Governor Ivon Levoltney similar takes from him as well. He's now left the Austrian Central Bank. But certainly that was his for you two. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud,

or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio