28/10/17: Supplies of Monetary Methadone: ECB's Recalibration

My take on ECB's latest policy announcements for the Sunday Business Post: https://www.businesspost.ie/opinion/supplies-monetary-methadone-will-continue-401179.

28/8/2014: Draghi at Jackson Hole: Not 'too little' but may be 'too late'...

Earlier this week I gave a comment for the Portugal's Expresss magazine article on ECB policy: http://expresso.sapo.pt/mario-draghi-descola-da-austeridade-demasiado-tarde=f887024

Here is the full comment I provided:

Q: Can we talk of a “change” in the mood regarding austerity policies after the Draghi’s Jackson Hole speech – too little is worse than too much?

A: Mario Draghi's speech at Jackson Hole was significant for a number of reasons.

Firstly, it is an important signal of the ongoing gradual re-orientation of the ECB attention away from technical inflation targeting toward more detailed consideration of the inflation-leading fundamentals. Technical targeting is still there, but the focus is moving toward the real economy. This is a signal that reinforces, tacitly, previous policy bases, especially the concept behind the TLTROs as opposed to traditional LTROs, as well as the structured asset purchases programme currently in design.

Secondly, the speech clearly signalled the ECB's return to direct opposition to the EU-led structural reforms policies. Specifically, Darghi's focus on unemployment signals growing frustration within the ECB that structural reforms are not working due to their poor implementation, unambitious design and for cyclical reasons. While the media opted to focus on the latter point, dealing with the issues of cyclical timing, and thus with 'austerity' policies, in my view, longer term perspective inherent in Mr Draghi's emphasis on unemployment warrants the view that the ECB is once again moving to pressure Euro area leaders to stay the course of reforms over the long run, even if temporarily opening the door to easing the pressures of reforms in the immediate future.

The above two points are very clear from Mr. Draghi's discussion of structural vs cyclical economic impacts of the Great Recession.

Thirdly, it is also clear that Mr. Draghi is positioning ECB closer and closer to deploying an outright large scale quantitative easing (QE). However, he is painfully aware of the fact that traditional QE will risk pushing Euro area sovereigns further away from the necessity to enact painful reforms and that political cycle is starting to reinforce misdirected economic incentives. Furthermore, he is aware that current yields on Government bonds are not only benign, but outright exuberantly optimistic. Thus, the issue, in Mr. Draghi's view, is not how much QE is needed, but rather of what type - a choice being between the traditional QE (sovereign channel), LTROs-based QE (banking channel), asset buying and TLTRO (private supply side channel) or deleveraging supports (private demand side channel).

The problem with ECB's current stance is exactly that its policy innovations so far ignored the last channel which represents most direct route to stimulating demand and investment, and are yet to specify the penultimate channel which represents direct route to a supply side stimulus.

On the balance, Mr. Draghi's speech was far from being 'too little', although it still might be 'too late'. He touched the most important issue bridging supply and demand sides of the economy - employment - but as he notes, structural dimension of unemployment in Europe makes it very hard for the ECB to enact a traditional set of policy tools suitable more for reducing cyclical unemployment.

5/6/2014: Why ECB might have found a cure that strengthens the disease

Today's announcement by the ECB Governing Council that the Bank will be charging a premium to hold private banks' deposits has the potential to generate two positive effects and one negative, in the short run, as well as another negative in the medium-term. The ECB cut its deposit rate to minus 0.1 percent from zero and reduced its benchmark interest rate to a record-low 0.15 percent.

On the positive side,

1. Lower repo rate can translate, at least partially, into lower rates charged on variable rate legacy loans and new credit extended to households and companies. It will also reduce the cost of borrowing in the interbank markets. This potential, however, is likely to be ameliorated, as in the past rate reductions, by banks raising margins to increase profitability and improve the rate of loans deleveraging. This time around, the ECB introducing negative deposit rates is designed to reinforce the effect of the lending rate reduction. Negative deposit rate means that banks will find it costly to deposit funds with the ECB, in theory pushing more of these deposits out into the interbank lending market. With further reduction in funding costs, banks, in theory can borrow more from each other and lend more into the economies, including at lower cost to the borrowers. Note: in many countries, like Ireland, reduced lending rates will likely mean a re-allocation of cost from tracker loans (linked to ECB headline rate, their costs will fall) to variable rates borrowers (whose costs will rise) washing the entire effect away.
2. Negative rates, via increasing supply of money into the economy, are hoped to drive up prices (reducing the impact of low inflation) and, simultaneously, lower euro valuations in the currency markets (thus stimulating euro area exports and making more expensive euro area imports. The good bit is obvious. The bad bit is that energy costs, costs of related transport services, other necessities that euro area imports in large volumes will have to rise, reducing domestic demand and increasing production costs.

On the negative side,

1. The ECB has spent all bullets it has in terms of lending rate policy. At 0.15 percent, there is very little room left for ECB to manoeuvre and should current policy innovations fail, the ECB will be left with nothing else in its arsenal than untested, dubiously acceptable to some member states, direct QE measures. 
2. But there is a greater problem lurking in the shadows. US Fed Chair, Janet Yellen clearly stated last year that deposits rates near zero (let alone in the negative territory) can trigger a significant disruption in the money markets. If banks withhold any funds from interbank markets, the new added cost of holding cash will have to be absorbed somewhere. If the banks pass this cost onto customers by lowering dramatically deposit rates to households and companies, there can be re-allocation of deposits away from stronger banks (holding cash reserves) to weaker banks (offering higher deposit rates). This will reduce lending by better banks (less deposits) and will not do much for increasing lending proportionally by weaker banks (who will be paying higher cost of funding via deposits). Profit margins can also fall, leading all banks to raise lending costs for existent and new clients. If, however, the banks are not going to pass the cost of ECB deposits onto customers, then profit margins in the banks will shrink by the amount of deposits costs. The result, once again, can be reduced lending and higher credit costs.

On the longer term side, assuming that the ECB measures are successful in increasing liquidity supply in the interbank markets, the measure will achieve the following: stronger banks (with cash on balance sheets) will now be incentivised (by negative rates) to lend more aggressively (and more cheaply) to weaker banks. This, de facto, implies a risk transfer - from lower quality banks to higher quality banks. The result not only perpetuates Europe's sick banking situation, and extends new supports to lenders who should have failed ages ago, but also loads good banks with bad risks exposures. Not a pleasant proposition.

By announcing simultaneously a reduction in the lending rate and the negative deposit rate, the ECB has entered the unchartered territory where negative effects will be counteracting positive effects and the net outcome of the policies is uncertain.

Aware of this, the ECB did something else today: to assure there is significant enough pipeline of liquidity available to all banks, it announced a new round of LTROs - cheap funding for the banks - to the tune of EUR400 billion. The two new LTROs are with a twist - they are 'targeted' to lending against banks lending to businesses and households, excluding housing loans. TLROs will have maturity of around 4 years (September 2018), cannot be used to purchase Government bonds (a major positive, given that funds from the previous LTROs primarily went to fund Government bonds). Banks will be entitled to borrow, initially, 7% of the total volume of their loans to non-financial corporations (NFCs) and households (excluding house loans) as of April 30, 2014. Two TLTROs, totalling around EUR400 billion will be issued - in September and December 2014. The ECB also increased supply of short term money. TLTROs are based on 4 years maturity. Ordinary repo lending will be extended in March 2015-June 2016 period to all banks who will be able to borrow up to 3 times their net lending to euro area NFCs and non-housing loans to households. These loans are quarterly (short-term). Crucially, to enhance liquidity cushion even further, the ECB declared that loan sales, securitisations and write downs will not be counted as a restriction on lending volumes.

Thus, de facto, the ECB issued two new programmes - both aimed to supply sheep money into the system: TLTROs (cost of funds set at MRO rate, plus fixed spread of 10 bps) and traditional quarterly lending. There was a shower of other smaller bits and pieces of policies unveiled, but they all aimed at exactly the same - provide a backstop to liquidity supply in the interbank funding area, should a combination of lower lending rates, negative deposit rates and TLTROs fail to deliver a boost to credit creation in NFCs sector.

Final big-blow policy tool was to announce suspension of sterilisation of SMP programme - I covered this topic here. The problem is that Mario Draghi claimed that non-sterilisation decision was acceptable, since non-sterilisation of SMP does not imply anything about sterilisation of OMT (his really Big Bazooka from 2012). He went on to say that ECB never promised to sterilise OMT in the first place. Alas, ECB did promise exactly that here. Update: WSJ blog confirming exactly this and published well after this note came out is here.

In line with this simple realisation - that non-sterilisation of SMP opens the door to outright funding of sovereigns by the ECB via avoidance of sterilising OMT - German hawks were already out circling Mr Draghi's field.

Germany's Ifo President Hans-Werner Sinn said: "This is a desperate attempt to use even cheaper credit and punitive interest rates on deposits to divert capital flows to southern Europe and stimulate their economies," Sinn said on Thursday in Munich. "It cannot succeed because the economies of southern Europe must first improve their competitiveness through labour market reforms. Long-term investors, in other words savers and life insurance policy holders, will now foot the bill," warned Sinn.

And there we go… lots of new measures, even more expectations from the markets and in the end, Germans are not happy, while Souther Europe is hardly any better off… In the long run - weaker banking sector nearly guaranteed… A cure that makes the disease worse?.. And if one considers that we just increased even further future costs of unwinding ECB's crisis policies, may be the disease has been made incurable altogether?..

Here are a couple of charts showing just how massive this legacy policies problem is (although we will face it in the mid-term future, not tomorrow):

Did Draghi just make the impossible monetary dilemma (here and here) more impossible?

7/4/2014: EU's latests dis-inspiring growth forecasts...

So German Ifo upgraded euro area growth forecasts for 2014 and the numbers are... well... dis-inspiring?

"The Eurozone recovery is expected to pick up in the first quarter of 2014 with a GDP growth rate of +0.4% (after +0.2%  and +0.1% respectively in the previous two quarters)." Blistering it ain't.

But wait, things are not exactly 'improving' thereafter: "Growth is forecasted to decelerate slightly in the following two quarters."

Actually, 2014 full year forecast is for 1.0%. I know, don't go running out with flowers and champagne on this one. It is lousy. And it is even more depressing when you pair it with a forecast of 0.8% for inflation.

I mean, good news: official recession is over. Bad news: the recovery is going to feel like stagnation this year. Bad news >> Good news. Doubting? See this table summarising growth forecasts by main components:

• Consumption is expected to rise by 0.5% - so euro area consumers (aka households) are lifeless for another year. Lifeless because Europe will remain jobless: "owing to fiscal austerity measures in some member States combined with a continuing labor market slack and slow growth in real disposable income."
• Investment is expected to rise 2.1%, which is good news as most of this is expected to come from capacity investment (equipment and tech, rather than building more shed, homes and hangars to accommodate for imports from China). You wanna have a laugh? Per Ifo: "Private investment will continue to grow over the forecasting horizon due to the increase in activity and the need for new production capacity after the sharp adjustment phase determined by the financial crisis." Let me translate this for you: things got so ugly during the crisis that old capital stock was left to deteriorate without proper maintenance and replacement. Now we are going to start replacing that which was made obsolete in the crisis. And we will call that growth. Or rather the 'Kiev Model of Growth': Torch --> Rebuild...
• Industrial production is expected to 'jump' 1.5% y/y which, when paired with consumption growth at 0.5% suggests that once again 2014 will see European workers toiling hard to provide luxury goods they can't afford themselves for the world's better-off, increasingly found outside of the euro area.

Ugly? You bet. Even before the crisis euro area wasn't known for healthy growth figures, but now, watch this recovery plotted in the following two charts:

If one ever needed an image of the culture of low aspirations, go no further - the above show that whilst growth is basically non-extant, a mere sight of anything with a '+' sign on it triggers celebrations in Brussels…

Oh, a little kicker: Ifo projections for growth and inflation are based on following two assumptions: "oil price stabilizes at USD 107 per barrel and that the euro/dollar exchange rate fluctuates around 1.38". Now, should, say Ukraine-Russia crisis spill over to deeper sanctions against Moscow, I doubt oil price will be sitting at USD107pb marker for long. And should Sig. Draghi diasppoint with (widely expected by the markets) QE measures, Euro/USD will jump out of that 1.38 range like a rabbit out of the proverbial hole chased by a hound. In either case, kiss the 'growth' story good bye...

There are more downside risks to this forecast than upside hopium in Mr. Rehn's cup of tea...

18/7/2013: One table, four entries, wealth of irony...

One cannot contain a sense of deep irony when looking at today's mid-day CDS markets snapshot from CMA:

In one table we have:

• Euro area CDS spread from Finland (implied cumulative 5 year probability of default of 2.02% - which is asymptotically zero), Greece (implied CPD of 50.85% after two previous defaults), and Cyprus (implied CPD of 65.39% after previous default). 
• Egypt (implied CPD of 41.22% after a coup d'etat) 

That's, as Mario Draghi put it on June 25th, "reflect[s] on the importance of a stable euro and a strong Europe" or perhaps, as he put it "the euro area is a more stable and resilient place to invest in than it was a year ago" or may be "I am confident that the project for Europe will continue to evolve towards renewed economic strength and social cohesion based on mutual trust, both within and across national borders, and above all stability". Take your pick... (link)

28/10/2012: ECB and technocratic decay?

Some interesting comments from BNP on ECB and Mr Draghi's tenure to-date. The note is linked here.  But some quotes are enlightening [comments are my onw]:

"While the ECB justifies the OMT as being to improve the functioning of the monetary system, the fact it has done nothing to help the monetary system in Ireland or Portugal suggests the scheme is about fiscal financing." [I fully agree]

"The balance-sheet implications of buying in the secondary market are the same as if bonds had been bought in the primary market. Mr Draghi’s adherence to the spirit of the Treaty is in question. We support his flexibility, however." [In the short run - yes, Draghi's flexibility is a necessary compromise. Alas, in the long run it is of questionable virtue. Hence, as I remarked ages ago, it's not the measures the ECB unrolls in the crisis that worry me, but the impossibility of unwinding them without wrecking havoc on the economy.]

"...Mr Draghi did [cut rates] in November and December [2011], taking rates back to where they started the year before the two misguided mid-2011 hikes. Mr Draghi cut rates again in July 2012, not only taking the refi rate below the 1% barrier (to 75bp), but also cutting the deposit rate to zero, apparently in an attempt to reinvigorate the interbank market (so far, fruitlessly). Mr Draghi should be praised for cutting rates and for overcoming the 1% barrier, in our view." [I agree.]

"However, he seems to be reluctant to take the deposit rate below zero, which looks timid. Moreover, he has failed to stimulate private credit supply. The LTRO has facilitated the expansion of credit to governments, but to some extent, this has crowded out private-sector credit, where growth is now down 0.8% y/y (-0.4% adjusted for sales and securitisation). The line that this is due to weakness in credit demand is a feeble excuse for the ECB failing to do enough to stimulate supply or to circumvent the lack of credit supply, for example, through credit easing. This has been the major failure of Mr Draghi’s tenure." [I am not so sure on BNP rejecting the idea of weak demand. Most likely, both weak supply and demand are reinforcing each other. More on this once we have our paper on SMEs access to credit published in working paper format, so stay tuned].

And the last blast, the potent one: "If central bankers don’t want politicians to mess with central banking, central bankers would be wise not to mess with politics. Mr Draghi was intimately involved in Italian politics and the demise of former Prime Minister Silvio Berlusconi’s tenure in the summer of 2011. More recently, his plans for the OMT were reportedly shared with the German chancellor’s office well in advance. The ECB is a very political animal under Mr Draghi. As the only institution with pan-eurozone power, a prominent role for the ECB in crisis resolution and a strong link to politics
may be unavoidable, and even desirable. But ultimately, such links may return to haunt it." [Yep, I agree. Mr Draghi's competence in office comes with a typical European price tag - get a technocrat and surrender checks and balances. This both signifies to the sickness at the heart of Europe (technocracy displacing democracy) and the inability of the 'patient' to develop institutional path for dealing with this sickness (with EZ potentially/arguably facing either a collapse in the hands of democracy or decay in the hands of technocracy).]

2/9/2012: Gun, no bullets, a charging bear

Via an excellent recent post on the SoberLook, here's a chart showing a Central Bank with no ammunition left to fire at the charging bear:

The chart plots the rapid rise of monetary base in Japan courtesy of BOJ.

And as to the portrait of the bear (via same post):

The above plots Japan's GDP y/y changes. Here's the point - in 20 years between 1995 and 2014 there will be not a single 5 year period in which Japan did not have a recession. Not a single one.

Now, recall that 'we will do everything necessary to rescue euro and, believe me, it will be enough' statement from Mr Draghi... BOJ needless to say tried the same... it has been working marvels for Japan's economy, albeit the yen is still there.

4/8/2012: Links to my analysis of ECB's policy shift

My thoughts on Mario Draghi's quiet coup are on FTAlphaville (here) and in The Globe & Mail (here). BusinessInsider also picks on my comments (here).

27/7/2012: Some thoughts on Draghi's thoughts

Just two reactions - reflective of the markets sentiment - to yesterday's statements by Mario Draghi:

Markets are thin, as Europe slides into its annual 'Beach lounge & sun screen' mode, but nonetheless yesterday's statement by the ECB chief is significant. Not a game changer overall, yet, but a sign that the team captain is starting to see the problem more clearly.

So what did he really say?

1. Raised a possibility of direct bonds purchases for distressed sovereigns (read: Italy and Spain) - in my opinion a minor issue. Take Spain - from now through mid-2015 it will need €542 billion to roll over existent bonds and fund itself, plus €20 billion potentially in regional financing. ECB's hands are currently relatively tied when it comes to rescuing Spain by the fact that two out of three tools ECB can use to do so are ineffective if not damaging to Spain. Usual policy tool of lowering interest rates will have little-to-no impact on Spain which is suffering from the same breakdown in the monetary policy transmission mechanism as the rest of the euro zone. Draghi hinted at as much within the overall euro area context. ECB can use the LTRO3 tool. Alas, (1) this would mean that LTRO3 will be explicitly focused on financing sovereign (as opposed to banking sector) needs; (2) financing Spanish Government via LTRO3 would only increase contagion from the sovereign to the banks and back to the sovereigns; (3) Unable to issue LTRO to a specific country, the ECB is likely to risk even more carry trade and contagion across the euro zone as the result of such a move. So the only tool left is SMP. ECB has built up some back pressure here with no SMP purchases in 19 weeks, hence the trigger reaction yesterday to Draghi's statement, but I have severe doubts this will work, even if restarted as the scope for SMP purchases for Spain would be well under €75-80 billion - a drop in the funding requirement.
2. Noted that elevated sovereign yields can restrict the monetary policy transmission mechanism (presumably via the heightened liquidity trap effects and carry-trade incentives), which would bring them within the ECB mandate. This is consistent with his statement to the EU Parliament earlier this month where he stressed that both inflation and deflation are part of the ECB mandate. More specifically, Draghi said that "The short-term challenges in our view relate mostly to the financial fragmentation that has taken place in the euro area... Investors retreated within their national boundaries. The interbank market is not functioning... the key strategy point here is that if we want to get out of this crisis, we have to repair this financial fragmentation... So [first] regulation has to be recalibrated completely." In other words, Draghi sees regulatory, not balancesheet barriers to interbank lending (and thus regulatory causes of a liquidity trap). Fine, but that does not mean a short-term response on the cards. And it does not mean a major departure from the previous position of the ECB that regulatory fix must be applied ahead of monetary fix.
3. Spoke about the fact that the ECB mandate is too restrictive to deliver effective monetary policy - again re-iteration on his statement to the EU Parliament and potentially a clear signal the ECB would not mind if its mandate was expanded. Yesterday, Draghi went further to link the ECB unbalanced mandate to the ECB's ability / willingness to act in the sovereign bond markets. This is what referenced in the quote that the ECB is 'ready to do whatever it takes' to preserve the euro. But the quote contains much more than that: "...another dimension to this that has to do with the premia that are being charged on sovereign states borrowings. These premia [relate to] default, with liquidity, but they also have to do more and more with convertibility, with the risk of convertibility. Now to the extent that these premia do not have to do with factors inherent to my counterparty – they come into our mandate. They come within our remit." FTAlphaville has a good note on the convirtibility bit (here).

In short, I don't read Draghi's statement as a major and definitive turnaround in the ECB policy, but rather a continued sign of ECB drift toward pressuring both: 

• the markets sentiment, and 
• the euro area policymakers to act to increase ECB powers and/or carry out significant policy framework changes (ESM, banking union etc).

Continued is the key word here, because, in my view, yesterday's statement is not as divorced from the earlier Draghi comments as some analysts might suggest (or wish for).

These pressures, however, is an important component of policy drift across the euro zone. Leaderless Europe needs a jolt from the ECB to force it out of policy stalemate. That such an approach might be working is reflected in this latest report from the 'front'.