Category Archives: ECB QE

14/3/16: T-Rex v Paper Clip: Of Draghi and His Whatevers…

Remember recent ECB commitment to start buying more non-sovereign, non-financial corporates' paper? It was the part of the blanket bombing with 'measures' deployed by Mario Draghi last week.

Here is my summary as a reminder: The European Central Bank cut its key lending rate to zero (from 0.05 percent) in March, slashing its deposit rate further into negative territory (to -0.4 percent from -0.3 percent). Desperate for stimulating slack corporate investment, the ECB also significantly expanded the size and scope of its asset-buying program, hiking monthly purchases targets from EUR60 billion to EUR80 billion. Worse, Mario Draghi also expanded the scope of the programme to include investment grade, euro-denominated debt issued by non-financial corporations. And he announced yet another TLTRO – a longer-term lending programme (4 years duration this time around, having previously failed to deliver any meaningful uplift in the corporate capex via three 3-year long programmes). The new TLTRO will be operating on the basis of the ECB deposit rate, effectively implying that Frankfurt will be giving away free money to the banks as long as they write new loans using this cash. Last, but not least, the finish line for the ECB’s flagship QE programme was pushed out into March 2017 from September 2016. And yet, the ECB’s leatest blietzkrieg into the uncharted lands of monetarist innovation ended with exactly the same outrun as was the case for the Bank of Japan few weeks before it.

What is important however is not the above summary, but the estimated quantum of paper that the ECB so courageously planning to buy in order to prevent Euro area from sliding in a Japan-styled depression.

Enter BAML with their estimate:
No, the lads ain't kidding. The Big Bang is at 100% of the market only EUR554 billion. Shaving off for some tightening of yields, stretching of spreads and eliminating holdings not available for sale, suppose ECB hoovers out 50% of the market. The latest 'stimulus' to the Euro area economy will be... EUR275 billion or so...

You can't make this up.

Or can you? Here's the problem, folks: Last time Bank of Japan’s policy rate was at or above 1% was in June 1995. Before the era of low rates on-set, Japanese economy managed to deliver average annual rate of real economic growth of around 3.6 percent. Since the onset of monetary easing, Japanese economic growth averaged less than 0.8 percent. Bad?.. Bad. But not as bad as in the glowing success of the Eurozone. Here, ECB policy rate fell below its pre-crisis historical low in March 2009 and continued on a downward trend from then on. This coincided with a swing in average real growth rates from 2.02 percent per annum to 0.05 percent. Yes, the numbers speak for themselves: since the start of the Global Financial Crisis, Euro area enjoyed average rates of economic growth that are 16 times lower than the same period average growth in Japan. No need to remind you which economy suffered from a devastating earthquake and a tsunami in 2011.

And to counter this, the ECB is deploying a measure that at most can deliver ca EUR275 billion. 

Forget the idea of going after the bear with a buckshot load. Try going after a T-Rex with a paperclip... 

9/2/16: Currency Devaluation and Small Countries: Some Warning Shots for Ireland

In recent years, and especially since the start of the ECB QE programmes, euro depreciation vis-a-vis other key currencies, namely the USD, has been a major boost to Ireland, supporting (allegedly) exports growth and improving valuations of our exports. However, exports-led recovery has been rather problematic from the point of view of what has been happening on the ground, in the real economy. In part, this effect is down to the source of exports growth - the MNCs. But in part, it seems, the effect is also down to the very nature of our economy ex-MNCs.

Recent research from the IMF (see: Acevedo Mejia, Sebastian and Cebotari, Aliona and Greenidge, Kevin and Keim, Geoffrey N., External Devaluations: Are Small States Different? (November 2015). IMF Working Paper No. 15/240: investigated “whether the macroeconomic effects of external devaluations have systematically different effects in small states, which are typically more open and less diversified than larger peers.”

Notice that this is about ‘external’ devaluations (via the exchange rate channel) as opposed to ‘internal’ devaluations (via real wages and costs channel). Also note, the data set for the study does not cover euro area or Ireland.

The study found “that the effects of devaluation on growth and external balances are not significantly different between small and large states, with both groups equally likely to experience expansionary [in case of devaluation] or contractionary [in case of appreciation] outcomes.” So far, so good.

But there is a kicker: “However, the transmission channels are different: devaluations in small states are more likely to affect demand through expenditure compression, rather than expenditure-switching channels. In particular, consumption tends to fall more sharply in small states due to adverse income effects, thereby reducing import demand.”

Which, per IMF team means that the governments of small open economies experiencing devaluation of their exchange rate (Ireland today) should do several things to minimise the adverse costs spillover from devaluation to households/consumers. These are:

  1. “Tight incomes policies after the devaluation ― such as tight monetary and government wage policies―are crucial for containing inflation and preventing the cost-push inflation from taking hold more permanently. …While tight wage policies are certainly important in the public sector as the largest employer in many small states, economy-wide consensus on the need for wage restraint is also desirable.” Let’s see: tight wages policies, including in public sector. Not in GE16 you won’t! So one responsive policy is out.
  2. “To avoid expenditure compression exacerbating poverty in the most vulnerable households, small countries should be particularly alert to these adverse effects and be ready to address them through appropriately targeted and efficient social safety nets.” Which means that you don’t quite slash and burn welfare system in times of devaluations. What’s the call on that for Ireland over the last few years? Not that great, in fairness.
  3. “With the pick-up in investment providing the strongest boost to growth in expansionary devaluations, structural reforms to remove bottlenecks and stimulate post-devaluation investment are important.” Investment? Why, sure we’d like to have some, but instead we are having continued boom in assets flipping by vultures and tax-shenanigans by MNCs paraded in our national accounts as ‘investment’. 
  4. “A favorable external environment is important in supporting growth following devaluations.” Good news, everyone - we’ve found one (so far) thing that Ireland does enjoy, courtesy of our links to the U.S. economy and courtesy of us having a huge base of MNCs ‘exporting’ to the U.S. and elsewhere around the world. Never mind this is all about tax optimisation. Exports are booming. 
  5. “The devaluation and supporting policies should be credible enough to stem market perceptions of any further devaluation or policy adjustments.” Why is it important to create strong market perception that further devaluations won’t take place? Because “…expectations of further devaluations or an increase in the sovereign risk premium would push domestic interest rates higher, imposing large costs in terms of investment, output contraction and financial instability.” Of course, we - as in Ireland - have zero control over both quantum of devaluation and its credibility, because devaluation is being driven by the ECB. But do note that, barring ‘sufficient’ devaluation, there will be costs in the form of higher cost of capital and government and real economic debt.It is worth noting that these costs will be spread not only onto Ireland, but across the entire euro area. Should we get ready for that eventuality? Or should we just continue to ignore the expected path of future interest rates, as we have been doing so far? 

I would ask your friendly GE16 candidates for their thoughts on the above… for the laughs…

3/12/15: Of Debt, Central Banks and History Repeats

Couple of facts via Goldman Sachs' recent research note:

  1. Since the start of 2008, U.S. corporate debt has doubled and the interest burden rose 40 percent. Even as a share of EBITDA, debt servicing costs are up 30 percent, so U.S. corporations’ ability to service debt has declined despite the average interest rate paid by the U.S. corporate currently stands at around 4 percent, as opposed to 6 percent in 2008.
  2. Much of this debt mountain has gone not to productive activities, but into shares buybacks and M&As. Per Goldman’s note: “…the changing nature of corporate balance sheets does raise the question, again, about the lack of organic growth and reinvestment post the crisis.”

And the net conclusion? “…the spectre of rising rates, potential global disinflation, declining operating profits and wider credit spreads continues to create near-term consternation for weak balance sheet stocks.”

Source: Business Insider

Oh dear… paging the Fed…

  • Meanwhile, per IMF September 2015 Fiscal Monitor, Emerging Markets’ corporate debt rose from USD4 trillion in 2004 to USD18 trillion in 2014. Much of this debt is directly or indirectly linked to the U.S. dollar and, thus, Fed policy.

Oh dear… paging the Fed again…

And just in case you think these risks don’t matter, a quick reminder of what Jaime Caruana, head of the Bank for International Settlements, said back in July 2014 (emphasis mine):

  • "Markets seem to be considering only a very narrow spectrum of potential outcomes. They have become convinced that monetary conditions will remain easy for a very long time, and may be taking more assurance than central banks wish to give… If we were concerned by excessive leverage in 2007, we cannot be more relaxed today… It may be the case that the debt is better distributed because some highly-indebted countries have deleveraged, like the private sector in the US or Spain, and banks are better capitalized. But there is also now more sensitivity to interest rate movements."

All of which translates, in his own words into

  • "Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally."

And as per current QE policies?

  • "There is something strange about fighting debt by incentivizing more debt."

Which, of course, is the entire point of all QE and, thus, brings us to yet another ‘paging Fed moment’:

  • "Policy does not lean against the booms but eases aggressively and persistently during busts. This induces a downward bias in interest rates and an upward bias in debt levels, which in turn makes it hard to raise rates without damaging the economy – a debt trap. …Systemic financial crises do not become less frequent or intense, private and public debts continue to grow, the economy fails to climb onto a stronger sustainable path, and monetary and fiscal policies run out of ammunition. Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent."

Now, take a look at the lengths to which ECB has played the Russian roulette with monetary policy so far:

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)...