Tagged: ECB

Exit ECB, stage right. Curtain falls.

So now we know. Draghi couldn’t have put it more bluntly: “we should get used to a period of higher volatility”. “The Governing Council was unanimous in the need to look through this”.  This is significant. It means:

1. The ECB will not be using their QE to smooth out spikes in bond yields. They WILL use it if inflation persistently undershoots expectations. This confirms that QE is a monetary policy tool – pure monetisation of the money stock, to shock inflation expectations higher. It’s not a market stability tool, unlike the QE we came to know and love from the Fed and the BOE. This is because the ECB is attacking a different problem from the market dislocations of the post Lehman era.

2. This explains the dichotomy between the Coeure “frontload QE” comments and the ECB’s actual lower purchases: they DON’T want to distort the market and they’re not playing verbal intervention games such as those favoured by the BOJ in their QE prime.

3. The ECB have likely loosened policy at the most pro-cyclical moment. It took them so long to respond to the deflation risk that they are now doing QE when the world is stabilising. That should mean that European stocks can rally, whatever happens to bonds. If bonds sell off on growth expectations, that’s good for equities. If they rally due to more QE, that’s also good for equities.

4. Draghi is relatively optimistic. The first reasons he gave for the sell off in Bunds? “Higher growth expectations”. The second? “Higher inflation expectations”. Only after that did he go onto technical reasons such as an excess of supply, and lower liquidity.

Adding this up = the ECB just gave the green light for bond yields to continue higher. As Draghi said, “inflation bottomed out at the start of the year”. The deflationary dragon is wounded, if not fully slain. Bund yields duly responded:

Bunds

Now, if this gets to a point where it tightens monetary conditions such that inflation expectations fall… then the arithmetic shifts. But until then we are in a hiatus with the Euro supported by rising yields, but hurt by ongoing Greek fears and the fact that deposit rates are still negative.

Separately, Draghi’s comments are a watershed for markets more generally.

We have heard countless warnings about the increased market volatility – the ECB have now joined the BOE, BIS, IMF and RBA in pointing out that low interest rates create these risks. But crucially, Draghi today pointed out that higher volatility is a sign of normalisation. A sign of the world getting better. It is not only to be expected, but to be welcomed.

This means that they will not be there to intervene from now on. That might sound strange, with ECB QE continuing, but just look at the market volatility that has caused in the once benign and solid German bond markets. Do not equate asset purchases with sedation for the patient. The patient is up off the operating table, out the hospital, and coming off the drugs. Understandably, the patient will not return to ‘normal life’ without emotional periods where he demands more drugs and then fails to get them. These tantrums will therefore persist.

Draghi’s comments today mean that we should embrace them. It’s time to wake up, and shake off Bobby’s Dream.

 

Enter the ECB, Stage Left

Which of these two charts will matter most for the ECB today?

1. Bund yields continue to climb, even after the Coeure comments two weeks ago that they might do more QE ahead of the less liquid summer months [not helped by the revelation the ECB actually bought less in the week of those comments]:

Bund 3 June 2015

2. European 5y5y inflation expectations were boosted by QE, up from their doldrums sub 1.5% -but they’re edging off from the highs above 1.8%:

EU 5y5y Infl exp

 

The market worries about chart 1, but Draghi is really only bound by chart 2, because this is what drives the ECB’s mandate. And on that measure, he’ll probably feel they’re doing OK, for now. Of course, he may have the fall out from Greece to deal with, but that should drive Bund yields lower on safe haven flows, and they now have the mechanism to calm bond markets should they need to.

We may therefore see a “steady as she goes” approach, which leaves the door open for the ongoing move higher in yields, the Euro, and a move lower in stocks as they realise deflation may be bottoming and it’s not QE-infinity…

Now you’re gonna believe us! The Draghi edition

The new piece of information we received from Mr. Draghi yesterday is that the ECB won’t buy bonds with yields below the depo rate, currently -20bp. With only Germany 2yr yielding there, this gives them plenty of room to buy almost anything, but more importantly it means they will HAVE to buy almost anything. They’ve got 60bn EUR each month to do, and if they get to -20bp, they go somewhere else. Expect flatter yield curves, and, as they can also go into agencies, tighter credit spreads.

It’s like Draghi just told the market his price, and how much he’s good for, and said (and this is a technical term) “Fill yer boots!”.

This just turbocharges the negative depo rate, encouraging even more use of the Euro as a funding currency.

Meanwhile, European equities have been boosted so much by this that we might be entering a phase of irrational exuberance. Or is it irrational if you’ve just mandated negative yields all along the curve…?

European equity flow

Rubicons and Shibboleths

Let us not shrug off last week’s action by the ECB – by putting forward a bold quantitative easing programme they have crossed the rubicon. It was said it could never be done; that European politics would never allow for it; that Mario Draghi would never get consensus, or that if he did, it would be a pea-shooter of QE rather than a bazooka. Yet here we are with a QE programme that:

– Is larger in size than most expected, in its initial scope of EUR 60bn of asset purchases for at least 18 months
– Is not just restricted to AAA rated securities, which had been mooted as the only way to get the hawks on board; in fact, Greece can be included if they remain within the bailout programme
– Includes an element of risk sharing
– Includes all bond maturities out to 30 years (no meddling just with the front end!)
– Can buy bonds with negative yields
– Is in fact open-ended, as Draghi said in his statement, that it ‘will in any case be conducted until we see a sustained adjustment in the path of inflation

You know by now that it is already having the desired effect. There is no reason why these trends should not continues: lower European yields, a lower currency, and booming stock markets. At some point the move into European assets may prop up the currency, but for now, FX remains dominated by monetary policy divergence and Europe just signalled they’d like to be bottom of the pile, thank you very much.

Now, it’s over to the politicians. Which segues nicely into the results that are just coming out of Greece. It looks like SYRIZA have had a great night, possibly winning the 151 seats required for an overall majority. Even if they fall short by one or two, this puts them in a very strong position for any coalition negotiations.

Rewind to June 2012. The threat of a SYRIZA election victory in the second election of that year, had been greeted with total doom and gloom. As it turned out, SYRIZA lost, and that period marked the lows in the European doom-fest. The Eurostoxx never looked back and has rallied 50% since then:

Eurostoxx since June 2012

The reaction couldn’t be more different this time around. SYRIZA’s leader and his deputies have been on a charm offensive with investors (“Us, radical Marxist revolutionaries? Nah mate, you’ve got us all wrong” would seem to be the message). But let’s look at Tsipras’ victory speech:

The victory was “a victory for all peoples of Europe fighting austerity”…”The mandate of the Greek people today cancels, in an indisputable way, the memorandums…It makes the troika a thing of the past

He is however a man about to enter into negotiations. This is the moment that he is at the height of his powers. A strong mandate from the people, a united party, and no gripes as he hasn’t yet had to enact anything. He also offered conciliatory tones, talking about a 4 year programme without running a fiscal deficit, adding:

The new Greek government will be willing to collaborate and negotiate with our European counterparts for a fair solution so that Greece can emerge from the vicious circle of debt”

Equally, the leader of one of his likeliest coalition partners Potami said that they would “not join a government with anti-Europeans“.

But here is the really big issue for Tspiras – can he keep his party together? Can he negotiate successfully now that the more extremist elements of his party will feel more than vindicated?

It’s important here to note the more significant aspect of this Greek election: The neo-Nazi Golden Dawn party came third and may end up with 17 seats. This, despite the fact that seven of their MPs including their leader, are currently in prison awaiting trial for being members of a criminal gang. It’s unlikely that they would ever form part of a coalition, being kryptonite for a functioning government, but it does show the depth of frustration in the Greek populace. This strengthens the hand of the more revolutionary wing of SYRIZA. This will not have escaped the attention of a potentially nervous Brussels. Note that the Belgian Finance Minister is already making conciliatory noises, sayingWe can talk modalities, we can talk debt restructuring, but the cornerstone that Greece must respect the rules of monetary union — that must stay as it is“.

So now we enter the big negotiation. Blondemoney is an optimist and believes that the Eurozone will preserve the union at almost any cost. However Blondemoney also believed two years ago that the ECB would never do QE; and a few months ago that the Swiss would never drop their currency cap. “Use Your Imagination” is the theme of this year and the big win for SYRIZA (and strong showing for Golden Dawn) raises expectations for the majority of the Greek parliament, not to mention the Greek people, that you can just walk away from your debts and expect no repercussions. If they push this too far, the Troika have plenty of mechanisms to threaten them with a cliff to throw themselves over. Starting now, the ECB have just allowed them a method to deny them participation in the QE programme. Politics is a game, and this game of chicken just got bigger.

All in all, it means: volatility will stay high, but rates will stay lower-for-longer, and the market will continue to play out the fight between the two. So we could see stocks and bonds keep going up in unison, but for currencies, you’ll need enough yield (or economic growth and political certainty) to compensate you for the higher volatility. The US dollar remains top of the tree but will the Fed change that with their meeting this week?

Oh and a thought to leave you with… the political impact from Greece will be felt across Europe, with anti-austerity and extremist parties emboldened. Expect to see a stronger showing for fringe parties, from the Greens in the UK, to the National Front in France, and Podemos in Spain (who were in attendance at the SYRIZA victory rally). And who is the next big country to have an election? (Forgive me Finland)

Roll on 7th May and the UK General Election…

All change please, all change

Canada’s surprise 25bp interest rate cut yesterday is significant. Not just because it had a big impact on the markets, but also because it shows the shift that is taking place since OPEC’s decision not to increase production at the end of November. Two months is not a very long time in central banking terms, but the drop in oil since then has evidently been so large that even if it were to rebound, the price shift would still be regarded as persistent. The Bank of Canada input $60 oil into their economic models, and felt they had to take action, even if it were only “insurance“, as Governor Poloz described it. This is how they see its impact:

BOC Chart 10

 

That kind of terms of trade shock has to impact the currency – and a weaker currency would be of benefit to them, as they explained in their statement: ‘The negative impact of lower oil prices will gradually be mitigated by a stronger U.S. economy, a weaker Canadian dollar, and the Bank’s monetary policy response’. The Canadian dollar can fall a lot further from here.

It also raises questions for other petro-economies, like Norway. They don’t have a rate decision until the 19th March, but given the speed of Canada’s volte face (back in October they were only daring enough to remove their tightening bias), we may see something significant from the Norges Bank then. The Governor of the Central Bank and the Prime Minister met last week for the first time since the financial crisis to discuss stimulus measures. We may see increased rhetoric ahead of the meeting. The market is pricing a 25bp cut, but after that only another 40bps of cuts for the rest of the year. Blondemoney had thought that a significantly weaker NOK, post-Rouble crisis, might stay their hand, given core inflation is already running above their target at 2.4%… but Canada’s core inflation was also at their target, at 2%. The BOC Monetary Policy Report devotes plenty of time to why core inflation is so high, claiming its an unusual boost from ‘meat and communications’ (!):

BOC Chart 12

 

When a central bank starts talking about excess supply of cattle, you know the jig is up. They want to cut rates and they’ve found their argument. Here are their new CPI forecasts – the top line is core inflation, which remains similar to the levels from their October MPR, while the bottom line is headline inflation. I think we can see which one they are really worried about:

2015 inflation forecasts

Meanwhile the Bank of England were merrily having their own panic about the fall in inflation. In September CPI was 1.5%. By December it had fallen to 0.5%. Such a speedy drop indeed looks frightening. Enough that the hawks on the MPC cancelled their calls for rate hikes at January’s meeting, fearful they would be earmarked as the loons who wanted to raise rates into deflation.

And now today, the ECB are about to cross the rubicon. Quantitative Easing, allegedly incompatible with Article 123 of the Lisbon Treaty which prohibits monetary financing of governments, is about to be announced. Although the market claims this is all fully expected, and indeed that it won’t have any impact anyway, they are still short Euros and long Eurozone bonds in anticipation. You can see the signs of nervousness after the price action yesterday, following the headline around 2.40pm that the ECB were considering a bond-buying programme of “50bn EUR through 2016”. EUR/USD dropped 50 pts, then rallied a big figure, before settling back down to where it started:

EURUSD 21 Jan 2015 spike

All of this was apparently caused by Bloomberg running the headline as “through 2016”. In British English, that probably means “through until 2016”, i.e. only one year, whereas in American English it means “throughout”, i.e. two years. The difference in total size of the programme would be EUR 600bn, depending on the extra 12 months.

Again, when markets become this freaked out by semantics, you know today’s decision is a big deal. The market is rightly nervous because it is so hard to predict what the programme will look like. Blondemoney suspects until today the ECB didn’t know exactly what the final plan would look like either. Through his entire Presidency, Draghi has thought big, and when he has consensus, he acts big. If the market is disappointed today, he’ll throw more at it tomorrow. So the question is – what does it mean for the Euro? It’s not unambiguously negative, given that reflation should see inflows into European assets, unlike how a negative interest rate has a direct currency impact. It may be that they also announce a rate cut today – or keep that one in the locker if the Euro doesn’t perform how they would like. In the short-term, however, everyone seems to expect a short squeeze, and to sell on rallies. That usually means you don’t get much of a rally. We should see 1.14 before 1.18 today. Hold on to your hats.