25/1/15: Swiss Out, Danes In: Pegs and Euro Mess

My comment from earlier this week on SNB and Denmark's Nationalbank pegs decisions (Expresso, January 24, 2015 page 09):

There are two truths about currency pegs.

The first one is that no Central Bank is an island. In other words, all pegs are temporary in their duration and costly in their nature, while held.

The second one is that exiting a peg with underlying conditions similar to those when the peg was set in the first place can never be a smooth and risk-free decision. Disruptive nature of such an exit is only highlighted by the necessity of the peg in the first place.


Swiss CHF to Euro peg is emblematic of the above two facts. The peg, de facto maintained from the summer 2011 (but officially launched on September 6, 2011) at the height of the euro area crisis, was designed to remove pressures on the Swiss Franc arising from the rapid acceleration of capital inflows from the euro area to Switzerland. The resulting inflows pushed values of CHF well beyond the sustainable bounds, threatening to derail the Swiss economy, heavily dependent (especially in 2011) on exports.

The cost of the SNB peg to the Swiss economy was manageable, but accelerating in recent months. As part of the peg, SNB printed CHF to purchase surplus euros. Bought euros were accumulated on the SNB balance sheet. recent devaluation of the euro against the US dollar, and expected future devalutations of the euro (on foot of upcoming ECB QE measures) pushes down the real value of these forex reserves accumulated by the SNB. Exiting the peg simply realigned these values to actual currency fundamentals and crystallised the loss in one go, de facto partially sterilising the inflows.

Chart below illustrates accumulation of Forex reserves by SNB from the peg introduction on September 6, 2011.

The disruption caused by the SNB exiting the peg has been significant. Some 46 percent of all Polish mortgages have been issued in CHF. Hundreds of thousands of loans in other Eastern European countries were tied to CHF as well. The cost of funding these loans rose by between 15 and 20 percent overnight, causing some panicked reactions from some Eastern European Central Banks. Beyond this, home-felt impact of SNB move has been less pronounced in the short run. However. in the longer term, stronger Swiss Franc is going to put severe pressure on Swiss exports and will likely result in deterioration in the overall balance of payments. Swiss economy is still heavily reliant on Forex valuations to support its global trade. Current world trade conditions - with the likes of Baltic Dry Index at 753,000 close to crisis period lows, and IMF projections for ever lower rates of global trade growth in 2015-2016 - all signalling serious pressures on Swiss exporters.


Denmark's decision to introduce a Krone/Euro peg this week is likely to fare about as well as that of the Swiss decision in 2011. Just as the Swiss, Danish regulators also set negative deposit rates to further reduce pressure on Krone from Euro inflows. However, the pressure on the Krone is rising not due to the crisis-related capital flight (as was the case with Switzerland in 2011-2013), but due to currency hedging in anticipation of the ECB quantitative easing move expected to be announced this week.

Danish peg is critically different from the SNB previous attempt to peg CHF. The reason for this is that Krone has a long-term link to the Euro and in effect current peg is simply a form of repricing this link. And, unlike CHF (which accounts for roughly 5.2 percent of global currency trading volumes), Krone is a relative minnow in the forex markets (its share of the global currency trade is only 0.8 percent).

The two factors make Krone peg more credible and less costly to defend over the medium term. But none of these factors help to alleviate the problem of currency valuations for Danish exporters, who will see their markets for exports more contested now that the Krone is appreciating against the Euro.

The reserves dynamics preceding the Denmark's peg introduction and the SNB peg announcement in September 2011 are similar: both currencies have sustained heavy 'buy' pressures and both pressures were driven by the crises in the euro area. SNB introduced the peg at relatively benign levels of forex reserves accumulation back in 2011 which, at the time, were nonetheless consistent with crisis-period peak levels. Denmark's Nationalbank's peg introduction also takes place close to crisis period peak of reserves accumulation and the question to be asked is: how much pain on DKK can Denmark take in this environment. 

24/1/2015: CB of Russia Recent Interventions

In 2014, Central Bank of Russia spent USD83 billion on currency interventions, against total draw down of USD124 billion in foreign reserves held. At the end of 2014, CBR’s foreign currency reserves, including gold, were USD386 billion, down from USD510 billion at the beginning of 2014. As of December figures, Russian foreign exchange reserves rank 6th largest in the world, providing a cover for more than 15 months of imports at current running rate.

In first half of January, CBR spend some USD2.2 billion on currency markets interventions, issued foreign exchange repos for the amount of USD8.3 billion, with most of this (USD5.4 billion) in 28- and 365-day maturities.

24/1/2015: ECB v Fed: Why Frankfurt's QE is a Damp Squib

A neat chart from Pictet showing balancesheet comparatives for ECB and the Fed.

Setting timing issues aside (which are non-trivial), the quantum of ECB balancesheet expansion planned is still too weak and it is too weak relative to previous peak. The Fed balancesheet expansion followed three stages:

• Stage 1 in 2008-2009 was sharp and more significant than for ECB.
• Stage 2 covered Q1 2009-Q2 2011
• Stage 3 covered Q1 2013 through Q3 2014.
• There were no major policy reversals, only moderation, over the entire QE period.

In contrast, ECB balancesheet expansions were weaker throughout the period, and were subject to a major reversal in Q1 2013 - Q3 2014 period.

In effect, even with this week's boisterous announcement, the ECB remains a major laggard in therms of monetary policy activism, compared to all other major Central Banks that faced comparable risks.

Now, to timing. ECB is a de facto your family doctor who routinely forgets to apply medicine in time and under-medicates the patient after the fact. Frankfurt slept through the Q1 2009-H1 2011 and went into a delirious denial stage in Q1 2013-H1 2014. The inaction during two key periods meant that nascent recovery of 2010 was killed off and 2013-2014 can be written off as lost years. The lags in policy reaction by the ECB are monumental: as the Fed ramped up monetary expansion in Q4 2012, the ECB will be presiding over a de facto monetary (balancesheet) stagnation, if not contraction, until March 2015. Which means that during the critical years of deleveraging - of banks and the real economy - debt reductions in the European economy were neither supported by the institutions (bankruptcy and insolvency resolution regimes), nor facilitated by the monetary policy. Instead, monetary policy simple delayed deleveraging by lowering the interest rates, without providing funding necessary for the writedowns. This is diametrically different to the US, where deleveraging was supported by both monetary policy and institutional set ups.

Meanwhile, Germans are now at loggerheads with the rest of Europe, whinging about the 'abandoned prudence' of the ECB. Best summary of why they are dead wrong is here: http://www.forexlive.com/blog/2015/01/23/eight-reasons-german-complaints-about-qe-and-the-eurozone-are-laughable/

The circus of the euro area pretence at economic (and other) policymaking rolls on. Next stop, as always, Greece...

23/1/2015: Davos 2*&%: I am not a fan... Why?

Narcissistic, self-obsessed, publicity equivalent of the Maybach Exelero and about as useful for its stated purposes too, Davos World Economic Forum is an media fest ritual that probably costs the world more trees (chopped for all the glossy publications it generates) than anything else on the global events calendar every year.

Corporates and their media love it. Journalists are awe struck by its trappings - from hotel rooms prices, to cost of basic meals, to who they bump into in the corridors. Big wigs of global business have to have it, because, apparently, they have trouble (with all their private jets and first class travel seats) meeting each other in real life in New York or London or Singapore, where they live. A handful of select, usually consensus-circling economists and pundits provide a backdrop of 'intellectualism' to the gathering. You can't tell sell-side from buy-side because it is all sell-side - sell your own image.

Yes, I am not a fan. And to explain why, let me give you this link via @CapX by @DanHannanMEP which explains the entire Davos event in its headline: http://www.capx.co/davos-is-a-corporatist-racket/.

H/T to @msgbi for highlighting the article.

23/1/2015: Russian Economy Growth Downgrades

On top of downgrades by the rating agencies, Russia also got downgraded by the host of international agencies - in terms of country growth prospects for 2015-2016. The IMF downgrade took 2015-2016 forecast for growth of 0.5% and 1.5% for 2015 and 2016 respectively published in October 2014 down to a contraction of -3.0% in 2015 and -1.0% in 2016. The Fund estimates 2014 GDP growth of 0.6% for the full year and Q4 2014 growth of zero percent compared to Q4 2013. Not bad for the economy going though a massive, multi-dimensional crisis. But a poor outlook for 2015-2016. IMF estimates are based on assumed oil price (full-year average weighted of 3 spot prices) at below USD60 but above USD55 (see http://blog-imfdirect.imf.org/2014/12/22/seven-questions-about-the-recent-oil-price-slump/), so closer to USD57.

The World Bank outlook, released on January 14th is a bit less gloomy when it comes to 2016. Per World Bank, "sustained low oil prices will weaken activity in exporting countries. For example, the Russian economy is projected to contract by 2.9 percent in 2015, getting barely back into positive territory in 2016 with growth expected at 0.1 percent." World Bank oil price assumption is USD66 per bbl.

EBRD notes that "Geopolitical risks from the Ukraine/Russia crisis remain significant, although they are contained for the time being." According to the bank, "Russia is projected to slip into recession, with GDP contracting by close to 5 per cent."  On more detailed assessment, EBRD says that: "In Russia, lower oil prices have compounded the effect of deep-seated structural problems, increased uncertainty and low investor confidence, along with the increasing impact of economic sanctions imposed since March 2014. In the first three quarters of 2014 investment continued to decline, consumption growth decelerated to below 1 per cent, and imports dropped by 6 per cent in real terms. Capital outflows more than doubled to an estimated US$ 151 billion in 2014. As a result, the rouble has lost almost half of its value in 2014 vis-à-vis the US dollar and Russia lost about a quarter of its international reserves, ending the year at around US$ 380 billion (including the less liquid National Welfare Fund). Markets were particularly shaken in late November/early December 2014, and the central bank had to raise its policy rate to 17 per cent to stem pressure on the currency. The government provided additional capital to a number of banks, temporarily relaxed certain prudential requirements for banks, and introduced measures to increase the supply on the foreign exchange markets by state-owned companies and put in place additional incentives for de-offshorisation."

An interesting footnote to the analysis is covering remittances from Russia. "Remittances from Russia to Central Asia and the EEC continued to decline (see Chart below). Partial data for the fourth quarter in 2014 suggest that the decline is likely to have accelerated in recent months, entering two-digit percentage rate territory, as the Russian economy weakened and the sharp drop in the value of the rouble reduced the US dollar (and also local currency) value of the remitted earnings. Lower remittances inflows will affect consumption adversely and likely add to downward pressures on a number of currencies in EEC and Central Asia, which also face reduced export demand and investment flows from Russia."

Crucially, EBRD forecasts also reflect downgrades on September 2014 outlook. EBRD now estimates 2014 growth to be at 0.4% (more gloomy than IMF estimate and down on 9.6% estimate at the end of Q3 2014), with a contraction of 4.8% in 2015, which represents a downgrade of 4.6 percentage points from September forecast. EBRD oil price assumption is around USD57-59 per bbl.

Chart below summarises unemployment trend 2013-2014:

23/1/2015: A Liquidity Fix for the Euro? What for?...

So Euro area needs liquidity... sovereign liquidity, right?

Take a look at the latest Eurostat data:

Even after all statistical 'methodology' re-jigging and re-juggling, Q1-Q3 2014 saw Government spending accounting for 49.5% of GDP and deficit averaged 2.43% of GDP. Meanwhile, debt/GDP ratio stood at 92.1% of GDP excluding inter-governmental loans (2.4% of GDP):

Yields on Government bonds are hitting all-time lows, including for 'rude health' exemplars such as Spain and Italy:

(credit @Schuldensuehner )

Clearly, liquidity is not  a problem for European sovereigns. But pumping in more liquidity into the euro system might just become a problem: the lower the yields go, the higher the debt climbs. With this, the lower will be the incentives for structural reforms, and the higher will be the debt overhang. All the while, without doing a ditch to repair the actual crisis causes: excessive legacy debts in the households' and corporates' systems.

Meanwhile, the press is lavishing praise on the ECB's Mario Draghi for... well I am not quite sure what is being praised: Mr Draghi is planning on doing in March 2015 what the Fed, BofE, and BoJ have been doing since (on average) 2009, albeit he is facing German (and others') opposition.

Being 6 years too-late into the game, Mr Draghi, therefore, is equivalent to a lazy and tardy student who finally showed up for the class after all other students have left, but bearing an elaborate excuse for not doing his homework.

22/1/2015: Don't Put Too Much Dosh on ECB's QE Dark Horse...

Today's ECB announcement of EUR60 billion per month from march 2015 through September 2016 QE aiming to take the ECB balance sheet up to EUR1.14-1.26 trillion (estimated, based on starting timing and treatment of 12% share of European institutions securities) has been dubbed a massive boost to the euro area, a watershed, a drastic measure and so on.

Official details are here: http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html

In truth, it is neither.

Quantum of Asset Purchases and Types of Assets

• Monthly EUR60 billion. This is lower (at current EUR valuations) than 'tapering' levels of Fed purchases (USD75 billion) and is lower than BofE interventions in 2009 which run at STG25 billion / month because EUR60bn ECB intervention is ca 7% of Euro area GDP, while BofE intervention was ca 20% of GDP.
• Monthly purchases will combine public and private sector securities. Which means the QE is really an add-on to ABS. Purchases will start in the secondary markets and will cover investment grade securities issued by the euro area governments and agencies and European institutions in the secondary market. The key objective is to 'inject new liquidity' to improve liquidity supply. Problem is: with majority of Government bonds in negative yields territory already, where is the targeted shortage of liquidity in the system? I can't find one.
• Limitation to investment grade cuts out Cyprus and Greece, but the ECB promised to include them into the programme under extended rules.
• Government and euro area agencies securities will be purchased on the basis of risk-sharing. Quantum of purchases will be proportional to Eurosystem shares of each National Central Bank (NCB). 
• For European institutions-issued securities,amounting to 12% of total purchases, 80% of purchased quantum to be held on NCB balance sheet, 20% on ECB balance sheet. The latter measure prompted some analysts to conclude that risks can be amplified for the already indebted sovereigns. But this is nonsensical for two reasons: 1) NCBs are part of the Eurosystem, and 2) NCBs will purchase liabilities of the state, so only risk attached to these liabilities is carried through. In simple terms, there cannot be any double liability, just in the same way as one cannot eat the same slice of cake twice. More fundamentally, liabilities of the NCBs do not have to match the NCBs assets, nor do they constitute a claim on NCBs assets. Here is an informative primer on the topic: http://www.bruegel.org/nc/blog/detail/article/1546-qe-and-central-bank-solvency/?utm_content=buffer25d2c&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer+(bruegel
• For National securities, there will be no risk sharing. So risk sharing only applies to Agencies-issued debt.
• As a part of QE announcement, the ECB has also altered the set up of the TLTROs (there are six more tranches of these forthcoming). TLTROs will now be priced at MRO set at the time of each TLTRO tranche. This will lower the cost of future TLTRO tranches by some 10 bps. Net result - TLTROs are now marginally more attractive.
• The ECB can cut short the asset purchasing programme if there is a signal of 'sustained improvement in inflation'.

Impact Assessment:

The measures are sign of desperation and frustration on ECB behalf. And not with the persistence of deflationary risks.

Instead, QE announcement was accompanied by another round of 'fighting' rhetoric from Draghi, who clearly continues to push member states and the European Commission to aggressively pursue structural markets reforms.

Draghi downplayed expectations for QE by stressing that QE only provides conditions to support growth. In his own words: "Monetary policy can create basis for growth but it's up to governments and Commission to make sure growth actually takes place". In so far as absent growth there won't be inflation, we, therefore, have a perfect excuse ex ante for any QE failure.

The key, however, is that we are now into the unchartered territory of watching the emergence of the second round effects of QE announcement.

The reason for this is that the direct impact - lowering Government borrowing costs - is effectively useless - the euro area as a whole is already enjoying record low yields. Meanwhile, market expectations of inflationary pressure over the longer horizon (e.g. 5yr/5yr spreads) are starting to price higher inflation, albeit modestly so.

Mr Draghi's claim that the measure is aimed at supplying liquidity is a red herring - a token nod to the German hawks. In reality, most likely, the QE will not unleash a wave of new credit creation.

More likely, we shall see some easing of deflationary risks, with inflation picking up in the medium term on foot of both QE and oil prices reversion back toward fundamentals-justified levels. Euro devaluation will also help to cover up underlying structural drivers for deflationary risks.

The real causes of deflationary risks in the euro area is weak demand. The latter is driven by collapse in after-tax household incomes and savings, and by the ongoing deleveraging of the households and firms. None of these can be helped by the QE.

Meanwhile, the QE is likely to provide some easier conditions for issuance of new Government debt. Currently, just under 50% of the euro area economy is accounted for by the Government spending. Pumping more spending into this economy is unlikely to do much for future growth and is hardly going to trickle down to the ordinary households. Which means that the entire QE exercise is dubious in nature. It will, however, significantly pads the pockets of bonds dealers and stock markets, and banks that hold these securities.

One caveat few noticed is that the ABS segment of the QE programme now falls under the remit of the NCBs. Which means that national authorities can select assets for purchases from the private sector. How this mechanism can prevent selection biases to, say, potentially favour so-called National Champions (larger state-owned entities and private monopolies) or corrupt selection of politically-connected enterprises and other similar behaviour is anyone's guess.

The circus surrounding the ECB announcement was (and remains) quite bizarre. The ECB announced effectively new (as in unknown to us before) measures to the quantum of roughly EUR114-260 billion, since it already previously set a target of ca EUR1 trillion balance sheet expansion.

Even more bizarrely, we know many details of the QE mechanism, but we have no idea as to the split between the sovereign bonds purchases and private asset purchases. We have no defined limit to the balancesheet expansion and we do not have a defined process for ending the programme (sudden stop or tapering).


Alternatives:

As I tweeted today, a viable alternative to the largely dubious QE would have been supporting household incomes and companies investment. This can be done more effectively via targeted and structured tax policies that are medium-term revenue neutral. One example, coincidentally, provided today in FT by Martin Feldstein: http://blogs.ft.com/the-exchange/2015/01/16/martin-feldstein-beyond-quantitative-easing-in-the-eurozone/

In the medium term, the key should be using monetary policy and fiscal policy to deleverage the economies: households, companies and governments. This is not being helped by the QE. Here is an interesting recent paper on the subject: http://www.bis.org/publ/work482.pdf.

In the long run, the key is finding real new catalysts for growth in the euro area that can compensate for the structural and demographic declines the EMU economies are suffering from. This too is not being helped by the QE.


Update 1: Here is the proportion by which ECB will allocate purchasing allowances for each NCB:

Update 2: And here is yet another reason why ECB's QE might not be the 'big bazooka' that will end markets fragmentation (aka increase credit supply to the real economy) - read bottom tweet first:

Courtesy of @Lee_Adler

22/1/2015: Some recent stats on Russian economy

Couple of recent stats for Russian economy:

• Federal Budget Deficit for 2014 full year was 0.5% of GDP or RUB328 billion (ca USD 5 billion). Meanwhile, the Cabinet prepared a new Budgetary plan for dealing with the crisis which includes RUB 1.375 trillion (USD21 billion) worth of new measures. Amongst reported changes: RUB 250 billion worth of state banks recaps funds via the National Wealth Fund; RUB 86 billion of new subsidies for agriculture, industry and health, plus some regional tax breaks for SMEs.
• As reported by the Russia Insider (http://russia-insider.com/en/2015/01/22/2624) Russian banks dramatically increased bad loans provisions in 2014, up 42.2% y/y compared to 16.8% growth in 2013. Based on Sberbank estimates, if oil averaged USD40/pbl over 2015, Russian banks provisions will have to rise some USD46 billion. Meanwhile, banks profits run some 40% below 2013 levels. In 2012, Russian banks profits stood at RUB 1 trillion (USD15.3 billion), and in 2013 profits were RUB 994 billion (USD15.2 billion). In 2014 banks profits fell to RUB 589 billion (USD9 billion). Ugly numbers.
• Rental values for Moscow apartments were all over the shop in Q4 2014: Economy Class average rental rate in Rubles rose 1.1% q/q despite reports of falling demand from the migrants, while Comfort Class average rentals were down 1% q/q. Business Class rental values were up 0.71% q/q, but Elite Class rentals were down massive 11.5% q/q. So mixed signals from the rental markets overall. 

21/1/2015: Ukraine Requests Extended Fund Facility from the IMF

So Ukraine made a (formal?) request for change in the IMF lending programme:

Of all places... in Davos. And Ms Lagarde is dead-pan sure that an agreement to proceed will follow from the IMF Executive Board... not that anyone could doubt that it will, but it might be a better tone not to jump ahead.

The quantum of funding requested is not known, but we already know that Ukraine's own estimates were USD15 billion back in November 2014. Since then, things did not improve, so the same figure is probably closer to USD18 billion. And I suspect that Ukraine will need at least USD20-25 billion over 2015-2017, even under rather positive assumptions.

I do hope they get a good rate on all this borrowing, as loans do require interest payments and principal repayments.

21/1/2015: ECB QE: Risk-Sharing or Risk-Dumping?

My comment for Expresso (January 17, print edition page 12) on what to expect from ECB next.


Given the deflationary dynamics, including the 5y/5y swap at below 1.50 and the first negative reading since 2009, there is a strong pressure on ECB to act. Crucially, this pressure is directly link to the ECB mandate. Additional momentum pointing toward ECB adopting a much more pro-active stance this month comes from the euro area leading growth indicators. Ifo's Economic Climate for the Euro Area continued to deteriorate in the Q4 2014 and January Eurozone Economic Outlook points to effectively no improvement in growth prospects in Q1 2015 compared to Q4 2014. Eurocoin indicator showed similar dynamics for December 2014.

At this stage, even the ECB hawks are in agreement that some monetary easing action is required and most recent comments from the ECB Governing Council members strongly suggest that there is strong momentum toward adopting a sovereign bonds purchasing programme.

The question, therefore, has now shifted toward what form will such a programme take.

Indications are, the ECB will opt for a programme that will attempt to separate risk of default from market risks. Under such a programme, the risk of sovereign default will be vested with the National Central Bank (NCB) of the bonds-issuing country, while the ECB will carry the market pricing risks.

The problem is that such a programme will directly spread the risk of fragmentation from the private sector financial system to the Eurosystem as a whole. If the NCBs carry direct risks (in full or in part) relating to sovereign default, the entire Eurosystem will no longer act as a risk-sharing mechanism and will undermine the ECB position as a joint and several institution.

Another problem is that if risks are explicitly shared across the ECB and NCBs, the ECB will become a de facto preferred lender, with rights in excess of NCBs and, thus, above the markets participants. Any other arrangement will most likely constitute a fiscal financing and will violate the restrictions that prevent non-monetary financing.

These twin problems imply that, unless the ECB fully participates in risk sharing with the NCBs, the QE programme will risk inducing much greater risk of repricing in the 'peripheral' euro states and thus can lead to greater fragmentation in the markets.

21/1/2015: Global Trade Indicators Flashing Red

Two very interesting charts reflecting upon the same macroeconomic reality: world trade is slowing down. Big time…

First, IMF revisions of the global trade growth rates forecasts for 2015 - now at their lowest in 12 months (chart courtesy of the @zerohedge):

And next, Baltic Dry Index series printing 753,000 currently, a level consistent with depths of 2009 crisis and 2012-2013 slump (chart courtesy of @Schuldensuehner) :

All in, the above highlights the powerless nature of large scale advanced economies' QE measures when it comes to reigniting global demand.

20/1/2015: IMF Global Growth Outlook 2015-2016: Europe Slips, U.S. Powers Away

My analysis of the IMF update to the World Economic Outlook is now available on Learn Signal blog: http://blog.learnsignal.com/?p=148