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Mario Draghi and the European Central Bank (ECB) shocked financial markets this week when they yet again revealed they were prepared to further combat a stagnating European economy. They announced they were lowering three key policy rates to their ‘lower bound’ and unveiled an unconventional QE style stimulus program to purchase non-financial private sector debt. Unfortunately, the implicit message delivered was that their policy options are becoming exhausted, and consequently further accommodative policy saw the euro fall over 2 cents on Thursday against the US dollar.

The trimming of the key policy rates is only somewhat significant as they have taken their deposit rate, the rate of interest charged to financial institutions, further into negative territory. Ideally, no financial institution is going to take a loss or pay the ECB interest to hold their cash overnight, and ultimately it’s a facility that will not be used. In theory, it’s to create the disincentive to deposit funds with the ECB, and instead incentivise them to make money available to the business sector.

The other key lending rate to focus on is the refinancing rate, which the ECB cut to 0.05 percent. This is similar to where the Federal Funds Rate in the US sits between 0 and 0.25 per cent, and at 1 per cent in Canada. And again, a marginal 10 basis point cut does not make a huge material difference to incentivize banks to now borrow more and make loans, but it almost acts as part of a last resort move for the ECB attempting to stave off a deflationary environment.

These further rate cuts seem like a last resort tool for the ECB in terms of utilizing their conventional policy tools, which clearly are not providing the incentives with the liquidity to spur economic activity in the respective economies. With powerhouses like Germany actually seeing GDP growth contract in the latest quarter, and Italy now entering a triple dip recession, this crisis still very much drags on in Europe. But the question is, as monetary policy sees a diminishing impact, can further accommodation prolong the structural reforms so desperately needed?

Mario Draghi said at his press conference that these measures will only work if they come with the structural reforms on the fiscal policy side, and that is left up to the individual European governments. But as the ECB looks to protect its mandate of price stability in the euro, similar to that of the US Fed, policies in the last week have entered the experimental phase as they begin their targeted bond purchases.

The biggest shortfall of monetary policy in Europe was that it was not filtering through to the businesses that hire workers and advance the economy. As was seen by continuously lowering policy rates, credit has largely remained unavailable to the small and medium size enterprises. The announcement of purchasing asset backed securities is the first step in how the ECB plans to combat this.

As Draghi dictated and the market reacted, this is a policy that ultimately weakens their currency, where on Thursday the euro reacted and fell to its lowest level since July of last year. Many are drawing comparisons to this and the Fed’s Quantitative Easing, or Abenomic’s and its three arrow approach in Japan. Moreover, the ECB is really the last major central bank to join the experimental policy party, and whether they will be successful is not the question, as six years into recovery, investors have learnt the hard lessons of not betting against central banks. Instead, what is the cost of experimental policy and ongoing government malaise?

A question we are still awaiting an answer to here in North America.

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Who would of figured that in a week when the US economy reported initial estimates of second quarter GDP growth of 4 per cent, that the Dow Jones Industrial Average would simultaneously erase its gains for the year. Investors are grappling with the notion of whether this economy is ready to break out or revert back to the moderate 2 per cent growth levels we’ve witnessed on average since escaping recession. Similar to the jobs report early Friday morning, gains were strong despite missing expectations, but it’s the troubling 2 per cent wage growth barely matching inflation that leads investors to pause and question the economic outlook, particularly as viewed from the lens of the US Federal Reserve, and what corresponding policy could potentially be.

The headline print for US GDP growth is certainly one that appears strong on paper. No question following a dismal start to the year that the three month period ending in June made up for some of the weakness from the winter freeze. But it was the fact that consumption, which attributes for approximately seven tenths of the US economy’s output only advanced at two and a half per cent. This is what leads to questions or uncertainty surrounding whether growth in inventory building by US businesses will be matched by a pickup from the American consumer, or whether the expenditure is simply a trade-off for business spending later in the year. Currently, it seems the latter, that the economy will simply revert back to trend, that seems to resonate with investors as the equity markets seem exhausted at current levels.

Friday’s job numbers added credence to this theme as the number of jobs created no longer seems to be the focal point of the Federal Reserve. As renowned PIMCO economist Paul McCulley suggests, we know longer have a US federal reserve that is satisfied with just lowering the jobless rate. The Fed, under Janet Yellen is making clear their mandate that wage growth and other structural problems in the labour market is of particular importance. So while the broader theme around the US market is strength in full time employment on a monthly basis and encouraged workers rejoining the workforce, the issue and focus for the Fed stays with the measure of long term unemployed, which did tick higher in July, and the need for an increase in wage growth to keep pace with inflation and productivity gains.

This cautiously strong economic environment is congruent with the fashion in which the US dollar is trading. Wednesday of this week, the US dollar index rose to a 10 month high following the GDP numbers, and the way in which the dollar gained fits with this goldilocks economy-not too hot, and not too cold. We are seeing resounding strength in the dollar and the potential for upside, but still the uncertainties of the Fed ending QE, shifting consensus on when the Fed will be able to raise the Federal Funds Rate, and even whether the weakness in the euro will follow through.

The puzzle for the markets in a week when the Dow lost close to 400 points (2.40%) and the S&P close to 50 points (2.46%) was that there was no clear safe haven. Gold floundered, government bonds found modest bids, and the US dollar, albeit, gathering some momentum, stayed relatively quiet. As the markets and the economy recouple into a period of perhaps more normalcy, the question becomes is the inevitable equity correction looming, or is this another buy the dip as markets climb at a not too hot, but not too cold pace.

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Gold prices gained for the sixth week in a row putting up the metals’ best winning streak since August of 2011. Beyond the technical factors that have been supporting this rally that started below 1,250 US per ounce, investors once again are demanding gold for its safe haven characteristics. It was the news of an extension of Portugal’s biggest bank missing an interest payment on their debt that saw investors sell equities and move into precious metals. And thus, the memory of the fears of a sovereign debt crisis in Europe (that investors had since moved passed), serves as a sobering reminder for the need of a hedge to equity exposure. This is amplified by the fact that we are in a rising interest rate environment when investors might want an alternative to bonds and other fixed income.

But it is interesting to think back to what the market reaction might have been two years ago if a similar event had happened to another one of Europe’s major financial institutions, and perhaps allows suggesting that the markets today are not as sensitive as they were in 2012. The selloff in the markets we saw on Thursday might have been much more drastic. And for that matter, the selloff could have followed through into Friday’s trading session as investors concern themselves over the condition of European banks’ balance sheets. Instead, banking fears in Europe translated to a half percent selloff in the S&P500 and the markets finished positive on Friday.

As immune as the markets may have been this week to the events in Europe, they have illustrated one thing, and that is as we remain in this low to moderate growth environment, we will continue to uncover vulnerabilities in our financial and economic system. This is simply because we are not seeing the robust economic growth that would allow us to put the crisis of 2007 behind us and move on. Portugal’s Banco Espirito Santo may not represent a major financial institution in comparison to perhaps the problems encountered by Spain’s Santander in October of 2012, and their exposure to the debunked Spanish housing market. But it does caution that there could be many more skeletons in the closet uncovered by this lifeless recovery.

The same is true for North America. Weak economic growth holds us back from correcting the shortfalls that led to the events of 2007. Despite analysts’ calls for a strong US economy in the second quarter of this year, it follows a near three percent contraction in the first three months. And it’s a similar scene in Canada, which is evident through the performance of a labour market in an economy that continues to illustrate a pure inability to create jobs.

My point is certainly not to be overtly bearish on some unforeseen events or hiding from what’s to come. Moreover, as the same structural problems are still prevalent in the global economy today, like stagnant employment growth, high government debt levels, and an ongoing societal debate surrounding social inequality, it’s hard to see what will spur a sudden shift to a rapidly growing economy. And for that reason it seems we can expect a few more shocks along the way, and investor’s continuing to turn to gold as the ultimate hedge.

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The Financial Times reported this week that central banks around the world are in the process of repositioning their portfolios as they pare back their exposure to US treasuries. They are doing this ahead of the US Federal Reserve ending Quantitative Easing (QE) this fall. Their rationale is that without the US Fed acting as the biggest single buyer of US government debt, excess demand for US treasuries will not be absorbed by the market at elevated prices, and thus will lead to higher interest rates. This should insatiably create a demand for gold, and the demand is from those that need to hedge exposure to US currency and US debt.

And so continues the threat of financial instability for global markets. Contrary to this though, the theme on Wall Street for the last few weeks has been on the abnormally high reported levels of investor complacency. This is gauged by the VIX (commonly referred to as the fear index) touching its lowest level in seven years, which was right before the financial crises of 2007. And this is exemplified by the fact that the major US indices have not made a move one per cent or wider in either direction in a single trading session in the last two months. To some, this is unsettling and continues to prompt calls for that overdue correction in equities.

But looking longer term or perhaps examining the implications of what a diminishing appetite for government debt by the world’s largest money managers means is what is a greater concern verses a lull in the markets. Tighter monetary policy is prompting central bankers, pension funds, and large scale investors that traditionally steer towards fixed income to allocate more capital to riskier assets such as equities. This chase or reach for yield, that many of the world’s brightest thinkers have precaution of is taking place. Riskier assets, and at times less liquid assets will have trouble offering the consistency and performance that some of these funds, like pensions, seek to achieve.

The other caution though that stems from this is the potential of these large scale investors losing the flexibility of their liquidity. Arguably, this would more be a threat to the stability of global markets, but according to the IMF, as 62 percent of all central banks investments were held in dollar based assets last year, it was undoubtedly the utility of the greenback as the world’s reserve currency that offered this convenience. The uncertainty going forward is determining the effect of the end of the dominance or reign of the dollar.

And this is again where precious metals play a role. The greatest risk to financial markets is how the US treasury market preforms when its biggest buyer, the Federal Reserve, is no longer in its role as a never ending buyer of US debt. It in part served this role in order to support a market of suppressed long term rates. The belief is that the demand and rush for equities will keep their prices trading higher as all types of investors continue to raise their exposure to risk assets. Unfortunately, this continues to tell a story of the stark differences between the financial markets and the underlying economy.

One will have to budge.

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The European Central Bank, as expected, unveiled a shotgun approach last Thursday to uplifting the Eurozone’s stagnating economy. The story with the ECB was that all they had to do thus far was wave their metaphorical policy weapon without every firing a bullet. By acting last Thursday, investors should question whether Europe’s problems are just beginning, or if it’s just Europe’s turn to embark on a beggar-thy-neighbour policy through euro devaluation.

It’s too early to tell, and perhaps too bold to call for Europe to enter into a deflationary spiral. What we have seen occurring is a period of disinflation, which is seen when the inflation rate slowly gravitates towards zero. This has been the increasing challenge for policy makers as it is the lacking demand of a healthy economy that is seeing the price levels move lower. But this is a problem of the global economy in the manner in which central banks have operated, particularly over the last six years.

The strengthening euro, whether it’s a result of unconventional monetary stimulus from the Federal Reserve, Bank of England, or Bank of Japan, is the reason for Europe’s sluggish economy. As other economies boosted stimulus measures and coordinately weakened their respective exchange rates, they are essentially exporting their lower prices to their trading partners. As their goods are now priced cheaper in foreign markets they typically saw that pick up demand which saw their inflation rates track marginally higher. Eurozone nations and businesses, as we know, faced the consequences of importing lower prices from their trading partners at the result of their relatively strong euro. Following Thursday’s announcement, if the ECB can be successful this is soon to change.

The measures implemented by the ECB on Thursday are their best effort to devalue the euro. Akin to the United States when the Federal Reserve expanded the level of accessible credit in their financial systems, there lacks the demand for those funds. Monetary Policy can create the right incentives for borrowers to want and have access to capital. It cannot, however, make the small and medium sized businesses that fuel the economy take on debt, invest in machinery, equipment, and technology, and hire employees.

The ECB’s main measures were directed at their financial institutions. The first was lowering their deposit rate to negative territory to create a disincentive from banks leaving funds with the ECB overnight. As of late, however, European financial institutions have slowly decreased the level of deposits left with the ECB. As well, Mario Draghi, President of the ECB announced changes to their Long-term refinancing operation (LTRO). And again, the theory behind banks being able to lock in financing for near zero rates for up to five years creates great incentives for borrowers, but the dilemma remains whether or not they will be utilized.

Among many of his great quotes, Yogi Berra famously said, “in theory there is no difference between theory and practice. In practice there is.” The theory is that the recent steps taken by the ECB should create the right incentives for participants in the Eurozone economies. The practice is what’s to come, but the uncertainty is whether Europe will get a turn at the table in the beggar-thy-neighbour global recovery.