Pro Perspectives 7/21/22

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July 21, 2022

The European Central Bank raised rates this morning for the first time in eleven years.  They surprised markets with a 50 basis point hike (market was expecting a quarter point). 
This takes the benchmark short-term lending rate in Europe to a whopping zero percent
Yes, after watching print after print of record high eurozone inflation (eight consecutive months of new, higher record inflation – resulting the chart below), the ECB is so interested in becoming inflation fighters that they have just now decided to exit negative interest rate policy.

If you somehow believed the lip service the Fed has been giving us, about alleged intentions to "expeditiously" raise interest rates, this view of Europe should set you straight.
The Fed has done a lot of talking, and yet has set (deliberately) the effective Fed Funds rate at 750 basis points UNDER the rate of inflation. 
In Europe, the ECB is 860 basis points UNDER the rate of inflation.
What tools do the central banks have to kill inflation?  Rates.  What does it take, historically, to kill inflation.  It takes moving the short-term rate ABOVE the rate of inflation.
Neither have done it.  And though they've done a lot of talking, they haven't even taken a "shot across the bow" with a big and bold rate move.  Remember, as Bernanke said, after launching QE to respond to the Great Financial Crisis, "we could raise rates in 15 minutes" to combat any concerning inflationary consequence.  
Bottom line:  As we've discussed often in these daily notes, even if the U.S. economy could withstand the pain of higher interest rates (which includes our government's ability to service its debt), the rest of the world can't.
Sticking with Europe, what would happen if the ECB were to really take on the inflation fight with higher rates?  The fiscally fragile countries of Europe would quickly become insolvent, unable to sustain on higher borrowing costs.  And the dominoes in Europe would begin to fall, which would lead to sovereign debt dominoes falling around the world.   
On that note, what did the ECB incorporate into today's decision?  A newly branded asset purchase plan.  On the one hand, they are telling the world they are "tightening" policy to curtail inflation, and on the other hand, they are restarting QE (reopening the liquidity spigot they just closed on July 1st). 
This new iteration of ECB QE, called the Transmission Protection Instrument (TPI), is a plan/threat to be the buyer of last resort of the sovereign debt of these weak eurozone countries, to keep a lid on their borrowing rates. 
What does it all mean? 
We can look to the interest rate market behavior today for the answer. 
After the first rate hike in Europe in eleven years, at a market surprising 50 basis points, key global interest rates moved lower on the day (that includes German and U.S. rates).
What will stocks do when the realization finally sets in that the Fed (and major global central banks) can't and won't do anything meaningful with interest rates?  Answer:  Stocks will soar.  
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