One of the themes of this blog is that the European Central Bank (ECB) is indulging in pro-cyclical policy rather than taking away the punchbowl when the party gets going. The dithering it displayed when the Euro area economy weakened meant that by the time it announced its 1.1 trillion Euro programme of asset purchases known as QE there were signs of a turn for the better anyway! Not only was the ECB claiming that its previous policies were working but the oil price more than halved and the price of other commodities fell too. Accordingly it has added a turbo-charger to the engine of the monetary boost it was already providing in a clear policy error.
Perhaps in a year or two’s time it will copy the words of US Federal Reserve Chair Janet Yellen who told us this yesterday.
Equity market valuations at this point are quite high. Now they’re not so high when you compare the returns on equities to the returns on safe assets like bonds which are also very low, but there are potential dangers there,
So the woman who has helped drive the balance sheet of the US Federal Reserve to over US $4 trillion and thereby pushed up all sorts of asset prices thinks they are now too high if we translate the central banker speech. No sign of a mea culpa there! Even worse she thinks that share prices are maybe okay because the prices of bonds which she has also driven higher are indeed high. Life as a central planner does not seem to involved having any awareness of the consequences of your own actions. I expect the ECB to exhibit this too as the consequences of its policies emerge in the coming months and years.
The Good News
This is that the Euro area has returned to growth as signaled by yesterday’s Markit Purchasing Managers Indices.
Eurozone growth continues as output rises across big-four nations…….April saw the rate of expansion in eurozone economic output hold broadly steady at March’s 11- month high.
This led to a forecast of solid if not spectacular economic growth in the first half of 2015.
The survey is signalling a rate of economic growth of approximately 0.4% at the start of the second quarter, similar to that indicated by the PMI in the first quarter.
Even Italy is now claimed to be expanding and Spain is at a 101 month high according to this measure. Although those with memories of the pre credit crunch era may experience some deja vu from the statements below.
Companies in Spain are seeing the largest inflows of new work for 15 years, while Ireland is enjoying one of its longest growth spells since the dot-com boom.
So whilst France is relatively stagnant and Greece is showing signs of getting even worse the ECB may think that things have finally got better and that some of the pressure placed upon it has eased.
Regular readers will have followed my updates on the various Bank of England forecasting errors and its efforts to be the worst forecasting organisation in the world! Well the ECB has made its own effort in this regard in recent times as illustrated by this from June last year.
Headline inflation is expected to increase from 0.7% in the first quarter of 2014
Instead it dropped to negative territory and is now as shown below.
Euro area annual inflation is expected to be 0.0% in April 2015, up from -0.1% in March
Now it was never likely to be on the ball concerning the oil price drop but having mistimed matters it now finds itself trying to push inflation higher just as the oil price is rebounding! From the low of January 13th the Brent Crude Oil benchmark is up 50% to US $68 per barrel. There is a deeper issue which is why the ECB treated zero inflation as so bad as after all one of the causes of the recovery is an increase in real wages caused by the drop in price of quite a few essential goods.
There was a spell where the impact of the ECB’s bond buying was that Euro area bond markets surged and yields plummeted. There was a clear moral hazard in countries at risk of default such as Italy and particularly Portugal as the central planners chose to misprice the risk. By the way is market-rigging not supposed to be a crime?
Along this road we saw many short-dated yields go negative especially in Germany and even the ten-year yield fell below 0.1% to 0.07%. An opportunity for Germany to borrow and invest?I will leave that there as an open question which is rarely discussed, and describe the next stage of events with a children’s nursery rhyme.
Oh, The grand old Duke of York,
He had ten thousand men;
He marched them up to the top of the hill,
And he marched them down again.
And when they were up, they were up,
And when they were down, they were down,
And when they were only half-way up,
They were neither up nor down.
We can now conclude that the impact of the ECB QE programme is to create extraordinary bond volatility. The German ten-year bond or bund then fell heavily in price terms such that it now yields 0.77% or back to where it was in early December 2014. As it is the leader of the pack the other Euro area bond markets fell too in sympathy with Portugal seeing its ten-year yield surging from 1.6% to over 3%!
All of the price plunge and yield rise has taken place since the 20th of April amidst complaints that there is no liquidity and the market is broken. Well if you will rig it! But there are all sorts of consequences from such wild swings as we know that those who make profits disappear into the ether but losses seem to invariably end up with the taxpayer.
Anyway how does increasing uncertainty and destroying liquidity in bond markets help the underlying economy? It does fulfill though some of the criteria of being in a bubble.
Still there is an upside which is that the ECB can now buy these bonds at a much lower price albeit shame about the 95 billion Euros bought so far.
UK Election Day
There have been some consequences across the channel in the UK from this. As @Schuldensuehner pointed out.
UK 10yr Bond yield jumps to highest level in 2015 on election day. Gilts have underperformed US treasuries this year.
The ten-year Gilt yield has pushed above 2% but before Telegraph leader writers get into a panic that they have missed an “election crisis” headline I replied with this.
Also the lowest Gilt yield on
#ElectionDay in the modern era!
The Euro exchange-rate
This has reversed course somewhat in recent times as it has risen to above 1.13 versus the US Dollar and pushed the UK Pound back down to 1.34. So the ECB finds that even deploying pretty much every weapon it has may no longer be working in the currency wars game. Still the Nordic nations and Switzerland will be relieved for now anyway.
There are all sorts of themes at play today. But let us start with the central one of mistimed QE. The central planning effort has found itself undermined by the rising oil price and the implications it has for future inflation. Thus the central planners find that the markets have treated even what are enormous sums like a mere bagatelle as we wonder if the bond vigilantes have returned? We have discussed in the past how interest-rates have been cut into a “liquidity-trap” well now the central planners at the ECB have managed to plunge bond markets into one as well. Future expectations of a tapering of the effort collide with higher yields which make it more likely to continue. Time for Ms Taylor Swift.
I knew you were trouble when you walked in
So shame on me now
Flew me to places I’d never been
Now I’m lying on the cold hard ground
Oh, oh, trouble, trouble, trouble
Oh, oh, trouble, trouble, trouble
Meanwhile outside the world of official statistics we see signs that even in Spain things may not be going as well as sometimes claimed. From Bloomberg talking to Guillermo Romero.
“I began looking for work at 20, I’m 27 and nothing has changed,” he said outside the unemployment office in the working-class district of Prosperidad in Madrid. “It’s pointless looking for work here. Most jobs pay no money or have nothing to do with your field.”