23/9/19: Corporate Finance in a Chart

The glut of debt and the unbearable lightness of corporate leverage:

12/6/19: All's Well in the Euro Paradise

All is well in the Euro [economy] Paradise...

Via @FT, Germany's latest 10 year bunds auction got off a great start as "the country auctioned 10-year Bunds at a yield of minus 0.24 per cent, according to Germany’s finance agency. The yield was well below the minus 0.07 per cent at the previous 10-year auction in late May. The previous trough of minus 0.11 per cent was recorded in 2016. Notably, demand in Wednesday’s auction was the weakest since late January, with investors placing bids for 1.6-times more than the €22bn that was issued."

Because while the "Euro is forever", economic growth (and the possibility of monetary normalisation) is for never... 

8/12/17: Happiness: Bounded and Unbounded

Why I love Twitter? Because you can have, within minutes of each other, in your tweeter stream this...

and this

That's right, folks. It's the Happiness Day: bounded at 0.2% annual rate of growth for the workers, and unbounded at USD11 trillion for the Governments. All good, right?

But of course all is good. We call the former - the 'great news' for the families, and the latter, 'savage austerity'.  Which is, apparently, good for the bonds markets... no kidding. At least there isn't a bubble in wages, even though there is a bubble in bonds.

11/6/16: 5,000 Years Record…

A quick classic from the 11-months-old Andrew Haldane’s chart plotting history of interest rates from 3000BC through NIRP/ZIRP

Oh, and yes, this is record low…

You can read the full speech here:
www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  - search for Haldane, June 30, 2015 speech.

16/4/15: QE and Negative Rates: It's So Good, It Hurts...

Here is an unedited version of my article for Manning Financial on the upcoming pain in the global markets from the Central Banks activism.


With spring sunshine, the glowing warmth of the overheating bonds markets is bringing about the scent of optimism to the macro-analysts' desks. On March 19th, the NTMA issued EUR500 million worth of 6mo notes with a yield of -0.01%. With a few strokes of the 'buy' keys, the markets welcomed Ireland to the ever-expanding club of nations that enjoy the privilege of being paid to borrow from private investors.

In a way, this is the story of Ireland's recovery distilled to a singular event: with the Government borrowing costs at their historical lows, the memory of the recent crises is fading fast from the pages of our newspapers. Alas, the drivers of this recovery are illusory. All are temporary, none are structural or sustainable, in the long run. In fact, the current markets reprieve is concealing the real dangers for domestic investors – dangers of new asset bubbles and potential future losses.

Take a look at the euro area sovereigns at large.

After years of austerity, 2015 is shaping up to be a year of broadly-speaking neutral public spending. In other words, as the euro area Governments' debt remains sky high, public deficits are unlikely to shrink by any appreciable amount. Why bother with reforms, when you can be paid by the markets to borrow? Aptly, as the chart below shows, European economic policy uncertainty remains at crisis period averages, well above the safety range of pre-crisis years.


European Policy Uncertainty Index  (including period averages confidence intervals)

Source: data from PolicyUncertainty.com


Although the Government is usually quick to claim credit for the massive improvements in Irish yields, in reality, Dublin has little to do with these. At every point from Q3 2011 through today, large scale declines in the Government cost of borrowing came courtesy of the ECB. The latest gains are no exception: the ECB has just launched a sizeable bonds-buying programme and with it, the quantum of negative yield debt in the global markets has gone from roughly USD3.6 trillion in January to USD4.2 trillion by mid-March. As of now, 19 percent of the Global Bond Index-listed debt is trading in negative rates territory.

This, by far, represents the largest long term challenge for investors and the greatest risk to the global economies. Expansionary monetary policy pursued by the central banks around the world, including the ECB aims to push up economic growth and reduce the risks of deflation. It also attempts to repair the monetary policy transmission mechanism: that cheap ECB-supplied liquidity is being lent by the banks to companies and households in the forms of new credit.


TANGIBLE RISKS

However, from the investors’ perspective, this monetary activism can end up backfiring. For a number of reasons.

Firstly, as shown in Chart 2 below, monetary policy-driven credit expansion is propelling stock markets and debt markets valuations to all-time highs across the advanced economies with absolutely no tangible connection to real fundamentals, such as growth in economic activity, household incomes, employment, and even capital investment. By the very definition of the financial bubbles, current monetary policies activism is inflating returns expectations unanchored in reality.

Secondly, monetary expansion means that households and firms struggling with debt are given a short-run reprieve from facing the true costs of their borrowings. But the day of reckoning awaits in the future. This means that households and corporates are likely to continue engaging in precautionary savings even as the Central Banks drop rates and bonds markets bid the cost of issuing debt down. Meanwhile, households and companies with low debt exposures are likely to save more to offset declines in their returns on deposits. Taken together, these factors are likely to further suppress domestic demand, while setting us up for a major crisis once the cost of debt starts rising in the future.

Thirdly, negative yields are, like all bubble-generating factors, self-reinforcing in their nature. With central banks increasingly charging commercial banks for deposits, banks prefer buying bonds even in the presence of the negative yields. This means that negative policy rates are reinforcing the dysfunctional monetary mechanism, locking in more liquidity into government bonds and driving yields on government paper further down. The resulting increases in bonds prices incentivise commercial banks to gamble on future capital gains by buying even more bonds. This spiral of demand for government debt depresses banks future profitability as investors bid bonds prices up and loads more risk of significant future losses that will materialise once QE policies begin to unwind.

Another pesky side effect of this is the banking sector stability. Negative interest rates on Central Bank deposits lead to lower deposit rates for banks' customers. Banking sector loans-to-deposits ratios rise, making banks more dependent on the shadow banking system for funding and more levered. Interestingly, in the U.S. at least one large bank, J.P. Morgan has already announced that it will be charging customers for large deposits up to 5.5 percent annual fee.

Fourthly, negative rates and yields are increasing the probability of monetary policy misfires - a scenario where one or several Central Banks around the world can tighten policy too fast and/or too early, completely derailing economic recovery. This problem is global and contagious. Investment grade government bonds are effectively substitutes for each other in majority of investment portfolios. As the result, negative yields in the euro area today are keeping yields low in other advanced economies. This is already causing discomfort in the U.S. where dollar rise relative to other currencies is being driven by a combination of two factors: the expected mismatch between U.S. and euro area policy rates, and investors' fear of Fed policy errors over the next 3-6 months.

Fifthly, the demand for negative yield bonds appears to be setting the unsuspecting investors for a fall. In a recent research note, the investment bank Jefferies discovered that much of the demand for such paper comes from indexed funds. Investors in these extremely popular funds simply have no idea that the strategy the funds pursue is not designed for the world where top-rated bonds are paying negative yields. And as funds start posting losses, the same investors are likely to rush for safety into other asset classes – namely equity. Yet, with equities already at historical highs, the safety-minded investors will be left with buying even more assets at bubble valuations.

Sixthly, negative yields on Government bonds are a disaster waiting to happen for insurance, asset management and pension sector as they create huge risks at the heart of these companies long-term investment portfolios. As insurance companies and pensions funds chase the yield, premia will have to rise, risks embedded in pensions portfolios will jump and returns on longer term contracts will fall. As the result, some financial analysts are warning of not only economic, but also political consequences of the monetary policy activism.

The bankers' regulatory body, the Bank for International Settlements is not amused. In a recent statement, Claudio Borio, the head of the BIS monetary and economic department said it is simply impossible to tell how investors, consumers, voters and the governments are going to react to the negative yields and interest rates. "…technical, economic, legal and even political boundaries may well be tested. The consequences should be watched closely, as the repercussions are bound to be significant, on the financial system and beyond," Mr Borio said.


IRISH INVESTOR PERSPECTIVE

From Irish investors point of view, the risks arising from the euro area negative rates and yields environment are significant.

In a study published in 2005 (http://www.bis.org/publ/work186.pdf), BIS researchers found asset price busts, especially those associated with large property markets adjustments, to have much more painful economic impacts than deflation. The study covered all advanced economies over the period from 1873 through 2004 and included analysis of deflation effects on Government debt and growth. The same results were on firmed by another BIS study published earlier this year (http://www.bloomberg.com/news/articles/2015-03-18/the-central-bank-of-central-banks-says-keep-calm-about-deflation).


Global Markets, Irish Problems

Source: Author own calculations based on data from CSO, Central Bank of Ireland and Bloomberg

As of today (see Chart 2), Ireland is still experiencing property prices that are 38 percent below the pre-crisis peak (in Dublin 39 percent), private debt that is, once controlled for sales of mortgages, and Nama and bank loans to non-banking investors, stuck around mid-2005 levels, and growth predominantly driven by the multinational corporations' tax optimisation strategies. In this environment, negative rates are masking the extent of the problems still present in the economy, while euro devaluation, coupled with exports growth concentration in the MNCs-led sectors, are creating a false impression of improved productivity and competitiveness.

For domestic investors, this means that both equity, corporate and government debt markets  in Ireland and across the euro area are simply out of touch with macroeconomic reality on the ground. The global Central Banks-led policies are pushing our traditional investment and pensions portfolios into the high risks, low returns corner, commonly associated with financial assets bubbles. While some speculative exposure to the US and Emerging Markets assets is always welcome, the bulk of investment allocation today should be focused on conservative view of key risks presented by the negative rates and yields environment. Tax planning, portfolio cost minimisation, low gearing and high liquidity of investment allocations should take priority over pursuit of short term yields and capital gains.

13/4/15: Bonds Traders: Give Us a Shake, Cause We So Sleepy...

Recently, I have been highlighting some of the problems relating to the Central Bank's driving up the valuations of government bonds across the advanced economies. In the negative-yield environment, the victims of Central Banks' activism are numerous - from banks to long-hold investors, to corporates, to capex, to savers, to... well... the fabled bonds trades(wo)men... the poor chaps (and chapettes) aren't even showing up for work nowadays: http://www.bloomberg.com/news/articles/2015-04-10/take-off-friday-and-monday-because-most-bond-traders-already-are because Sig. Mario is making their lives sheer misery with his euro bonds acrobatics.

Apparently, there is just not that big of a demand out there for the idea of giving money to the Governments on top of paying taxes and trading volumes are now where the rates are - in the zero corner. So the 'industry' solution is, predictably, for the Fed to raise rates. When was the last time you heard the car manufacturers begging regulators for a safety recall of their vehicles 'to jolt the complacent consumers a bit'?

2/1/2015: Negative Deposit Rates: Swiss Method

The best explanation of the Swiss negative deposit rates intervention I've read so far is here: http://perspectives.pictet.com/2014/12/19/switzerland-the-snb-introduces-negative-interest-rates/ via Pictet Perspectives.

9/6/2014: ECB Will Still Need Outright QE...

My comments on ECB policy moves last week and what awaits euro area in terms of monetary policies in the near future is on Expresso website (Portuguese) : http://expresso.sapo.pt/bce-pode-estar-a-alimentar-duas-bolhas-financeiras=f874782 and a longer version in English here: http://janelanaweb.com/novidades/constantin-gurdgiev-ecb-will-need-further-measures-including-an-outright-qe/

Needless to say, no one in the Irish mainstream media asked for my two-pence.

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?

25/4/2014: ECB, Denmark & Negative Rates, 'Peripherals' & Russia: today's links

Rumours mills been busy of late with all the talk about ECB doing 'whatever it takes' to get inflation going again. See this for example: http://www.spiegel.de/international/europe/ecb-prepares-measures-to-combat-possible-deflation-a-965636.html

Here is the best take on Denmark's brief brush with ECB's (allegedly) favourite weapon: the negative deposit rates:
http://www.bloomberg.com/news/2014-04-24/danish-central-bank-exits-negative-rates-first-time-since-2012.html


But while we are on topic of things monetary and fiscal, here is Euromoney take on what's been happening in the markets for 'peripheral' sovereign debt (note: my comment at the bottom): http://euromoney.msgfocus.com/c/123DSxhABTIFoVxuegyp64hKZL and alternative link: http://www.euromoney.com/Article/3334400/Category/14091/ChannelPage/8959/Ireland-and-Spain-lead-the-way-on-a-long-road-back-for-the-eurozone-periphery.html

To give you more context, here is the full comment I made:

The numbers cited are even better summarised in my earlier post on the subject here: http://trueeconomics.blogspot.ie/2014/04/2342014-some-scary-reading-from-eurostat.html

Meanwhile, here's what has been happening in the sovereign debt markets today - CDS spreads:

And finally, Russian credit downgrade: http://in.reuters.com/article/2014/04/25/russia-economy-ratings-idINL6N0NH19I20140425