Category Archives: euro area QE

21/7/17: Professor Mario: Meet Irish Austerity Unsung Hero

In the previous post covering CSO's latest figures on Irish Fiscal metrics, I argued that the years of austerity amount to little more than a wholesale leveraging of the economy through higher taxes. Now, a quick note of thanks: thanks to Professor Mario Draghi for his efforts to reduce Government deficits, thus lifting much of the burden of real reforms off Irish political elites shoulders.

Let me explain. According to the CSO data, interest on Irish State debt obligations (excluding finacial services rescue-related measures) amounted to EUR 5.768 billion in 2011, rising to EUR7.298 billion in 2012 and peaking at EUR 7.774 billion in 2013. This moderated to EUR 7.608 billion in 2014, just as Professor Mario started his early-stage LTROs and TLTROs QE-shenanigans. And then it fell - as QE and QE2 programmes really came into full bloom: EUR6.854 billion in 2015 and EUR6.202 billion in 2016. Cumulative savings on interest since interest payments peak amounted to EUR2.65 billion.

That number equals to 75% of all cumulative savings achieved on the expenditure side (excluding capital transfers) over the entire period 2011-2016. That's right: 3/4 of Irish 'austerity' on the spending side was accounted for by... reduction in debt interest costs.

Say, thanks, Professor Mario. Hope you come visit us soon, again, with all your wonderful gifts...

28/2/16: ECB in March: A Thaw or a Spring Blizzard?

My comment on what to expect from the ECB in March for Expresso

As usual, full comment in English here:

While the transmission mechanism has been improving in recent months across the euro area, leading to stronger lending conditions across the common currency area and a wider range of the member states' economies, inflationary dynamics remained extremely weak, even when stripping out the effects of oil and other commodities prices. As the result, ECB continues to see inflation as the key target and is likely to intensify its efforts to boost price formation mechanism.

Thus, despite all the ECB efforts, inflation remains stubbornly low and even slipping back toward zero in more recent data prints. Improved lending is not sufficient to create a major capex boost on the ground, weighing heavily on growth dynamics. Lower costs of borrowing for the euro area governments, while providing significant room for fiscal manoeuvre, is simply not sufficient to sustain a robust recovery. About the only functioning side of the monetary policy to-date has been the devaluation of the euro vis a vis the US dollar - a dynamic more influenced by the Fed policy stance than by the ECB alone.

My expectation is that the ECB will cut its deposit rate to -40 bps (a cut of 10 basis points on current) with a strong chance that such a cut can be even deeper. We can further expect some announcement on an extension of the QE programme beyond the end of 1H 2017.

The key problem, however, is that the ECB is also becoming more and more aware of the evidence that past QE measures in Japan, the UK, the euro area and across Europe ex-Euro area have failed to deliver a sufficient demand side boost to these economies. Thus, in recent months, the ECB has been increasing rhetorical pressure on member states governments to engage in supply side stimuli. Unfortunately, this too is a misguided effort.

In the present conditions, characterised by markets uncertainty, heavy debt overhangs and mis-allocated investment on foot of previous QE rounds, neither supply nor demand sides of the policy equation hold a promise of repairing the euro area economy. In addition, accelerated QE will likely feed through to the markets via higher volatility and possible liquidity tightening (bid-ask spreads widening, fear of scarcity of high quality government bonds and uncertainty over viability of the current monetary policy course).

29/12/15: There Are Two Ways 2016 Can Play Out for Euro Area Bonds

With the pause in ECB QE over the holidays season, bond markets have been largely looking forward to 2016 and counting the blessings of the year past. The blessings are pretty impressive: ECB’s purchases of government bonds have driven prices up and yields down so much so that at the end of this month, yields on some USD1.68 trillion worth of Government bonds across 10 euro area countries have been pushed below zero.

Per Bloomberg chart:

Value of bonds with yields below ECB’s -0.3% deposit rate, which makes them ineligible for purchases by the ECB, is $616 billion, just shy of 10 percent of the $6.35 trillion of bonds covered by the Bloomberg Eurozone Sovereign Bond Index. As the share of the total pool of marketable European bonds, negative yield bonds amounted to more than 40% of the total across Europe at the start of December (see here:

Two questions weigh on the bond markets right now:
1) Will the ECB expand the current programme? Market consensus is that it will and that the programme will run well beyond 1Q 2016 and spread to a broader range of securities; and
2) Will low inflation environment remain supportive of monetary easing? Market consensus is that it will and that inflation is unlikely to rise much above 1% in 2016.

In my view, both consensus positions are highly risky. On ECB expectations. Setting aside inflationary dynamics, ECB has continuously failed to ‘surprise’ the markets on the dovish side. Nonetheless, the markets continued to price in such a surprise throughout 2015. In other words, current pricing is probably already reflecting high probability of the QE extension/amplification. There is not much room between priced-in expectations and what ECB might/can do forward.

Beyond that, my sense is that ECB is growing weary of the QE. The hope - at the end of 2014 - was that QE will give sovereigns a chance to reform their finances and that the economies will boom on foot of cheaper funding costs. Neither has happened and, if anything, public finances are remaining weak across the Euro area. The ECB has been getting a signal: QE ≠ support for reforms. And this is bound to weigh heavily on Frankfurt.

On inflationary side, when we strip out energy prices, inflation was running at around 1.0% in November and 1.2% in October. On Services side, inflation is at 1.2% and on Food, alcohol & tobacco it is at 1.5%. This is hardly consistent with expectations for further aggressive QE deployment and were ECB to engage in more stimulus, any reversion of energy prices toward the mean will trigger much sharper tightening cycle on monetary side.

The dangers of such tightening are material. Per Bloomberg estimate, a 1% rise in the U.S. Fed rates spells estimated USD3 trillion wipe-out from the about USD45 trillion valuation in investment-grade bonds issued in major currencies, including government, corporate, mortgage and other asset-backed securities tracked by BAML index:

Source here.

European bonds are more sensitive to the ECB rate hikes than the global bonds are to the Fed hike, primarily because they are already trading at much lower yields.

Overall, thus, there is a serious risk build up in the Euro area bond markets. And this risk can go only two ways in 2016: up (and toward a much worse blowout in the future) or down (and into a serious pain in 2016). There, really, is no third way…

28/8/15: Inflation Expectations: Euro and U.S.

Having earlier posted a chart on Central Banks balancesheets expansion (see here), here is an interesting chart plotting inflation expectations (5yr5yr swaps - effectively markets expectations for 5 years from now inflation average over subsequent 5 years)

The above shows that although there has been an uplift in Euro area inflation expectations over the course of 2015 to-date, consistent with QE carried out by the ECB, the expectations have tanked since the start of Q3 2015 in line with those in the U.S.

More ominously, expectations remain in the territory where neither the Fed nor the ECB are capable of convincingly exiting monetary easing.

While the U.S. expectations are closer to target (at 2.23%) but still weak, Euro area expectations are exceptionally weak at 1.63%. Gotta do some more printing (for ECB) and less talking about tapering (for both the Fed and the ECB)...