In the future will everybody be paid to issue debt?

This morning has brought a couple of developments on a road I have both expected and feared for some time. This road to nowhere became a theme as I questioned how central banks would respond to the next slow down? We have two examples of that this morning as we see industrial profits in China fall 14% year on year after quality adjustment or 27% without ( h/t @Trinhnomics). Also we have some clear hints – much more useful than so-called Forward Guidance – from ECB President Mario Draghi. So let me jump to a clear consequence of this.

The stockpile of global bonds with below-zero yields just hit $10 trillion — intensifying the conundrum for investors hungry for returns while fretting the brewing economic slowdown.

A Bloomberg index tracking negative-yielding debt has reached the highest level since September 2017………

This latest move if you look at their chart has taken the amount of negative yielding debt from less than US $6 trillion last September to US $10 trillion now as we observe what a tear it has been on. So if you buy and hold to maturity of these bonds you guarantee you will make a loss. So why might you do it?

While negative yields on paper suggest that investors lose money just by holding the obligations, bond buyers could also be looking at price gains if growth stalls and inflation stays low. But along the way, risk assets may be entering the danger zone.

So one argument is the “greater fool” one. In the hope of price gains someone else may be willing to risk a negative yield and an ultimate loss should they hold the bond to maturity.

However there always ways a nuance to that which was that of a foreign investor. He or she may not be too bothered by the risk of a bond market loss if they expect to make more in the currency. This has played out in the German and Swiss bond markets and never went away in the latter and is back in the former. Also investors pile into those two markets in times of fear where a small loss seems acceptable. This has its dangers as those who invested in negative yielding bonds in Italy have discovered over the past year or two.

The more modern nuance is that you buy a bond at a negative yield expecting the central bank to buy it off you at a higher price and therefore more negative yield. Let me give you an example from my country the UK yesterday afternoon. The Bank of England paid 144 for a UK Gilt maturing in 2034 which will mature at 100. This does not in this instance create a negative yield but it does bring a much lower one as a Gilt issue with a 4.5% coupon finds its yield reduced to 1.32%. There was a time the thought that a UK Gilt would be priced at 144 would only raise loud laughs. I also recall that the Sledgehammer QE of the summer of 2016 did create negative yields in the UK albeit only briefly. Of course in real terms ( allowing for inflation) that made the yield heavily negative.

The Euro area

The activities of the European Central Bank under Mario Draghi and in particular the QE based bond buyer have added to the negative yielding bond total. This morning he is clearly pointing us to the danger of larger negative interest-rates and yields as he focuses on what to him is “the precious”.

We will continue monitoring how banks can maintain healthy earning conditions while net interest margins are compressed. And, if necessary, we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any. That said, low bank profitability is not an inevitable consequence of negative rates.

This matters because so far banks have found it difficult to offer depositors less than 0%. There have been some examples of it but in general not so . Thus should the ECB offer a deposit rate even lower than the current -0.4% the banks would be hit and for a central banker this is very concerning. This is made worse in the Euro area by the parlous state of some of the banks. Mario is also pointing us towards the ” favourable implications of negative rates for the economy” which has led Daniel Lacalle to suggest this.

Spain: Mortgage lending rises 16% in the middle of a slowdown with 80% of leading indicators in negative territory.

There is an attempt by Mario to blame Johnny Foreigner for the Euro area slow down.

The last year has seen a loss of growth momentum in the euro area, which has extended into 2019. This has been predominantly driven by pervasive uncertainty in the global economy that has spilled over into the external sector. So far, the domestic economy has remained relatively resilient and the drivers of the current expansion remain in place. However, the risks to the outlook remain tilted to the downside.

Those involved in the domestic economy might be worried by the use of the word “resilient” as that is usually reserved for banks in danger of collapse and we know what invariably happens next. But no doubt you have noted that in spite of the rhetoric we are pointed towards the economy heading south.

Then we get the central banking mic-drop as we wonder if this is the new “Whatever it takes ( to save the Euro)”.

We are not short of instruments to deliver on our mandate.

That also qualifies as an official denial especially as the actual detail shows that things from Mario’s point of view are not going well.

The weakening growth picture has naturally affected the inflation outlook as well. Our projections for headline inflation this year have been revised downwards and we now see inflation at 1.6% in 2021. Slower growth will also lead to a more muted recovery in underlying inflation than we had previously expected.

Comment

We have seen today that not only are there more people finding that debt pays in a literal sense but we have arrived in a zone where more of this is in prospect. I have explained above how this morning has brought a suggestion that there will be more of it in the Euro area and by implication around Europe as it again acts as a supermassive black hole. But let me now introduce the possibility of a new front.

Back in the 1980s the superb BBC television series Yes Prime Minister had an episode where Sir Humphrey Appleby suggests to Prime Minister Jim Hacker.

Why don’t you announce a cut in interest-rates?

Hacker responds by saying the Bank of England will not do it to which Sir Humphrey replies by suggesting a Governor who would ( and then does…). Now in a modern era of independent central banks that cannot possibly happen can it?

 He said the Fed should immediately reverse course and cut rates by half a percentage point.

Those are the words of the likely US Federal Reserve nominee Stephen Moore as spoken to the New York Times. Just in case you think that this is why he is on his way to being appointed I would for reasons of balance like to put the official denial on record.

And he promised he would demonstrate independence from Mr. Trump, whose agenda Mr. Moore has helped shape and frequently praised.

Returning directly to my theme of the day this in itself would not take US yields negative but a drop in the official interest-rate from 2.5% to 2% would bring many other ones towards it. For a start it would make us wonder how many interest-rate cuts might follow? Some of these thoughts are already in play as the US Treasury Note ten-year yield which I pointed out was 2.5% on Friday is 2.39% as I type this, In the UK the ten-year Gilt yield has fallen below 1% following the £2.3 billion of Operation Twist style QE as it refills its coffers on its way back to £435 billion.

 

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ECB monetary policy can inflate house prices at least….

Tomorrow the European Central Bank meets for what has become a crucial policy meeting. There is a lot for it to discuss on the economic front and let us open with an element of deja vu.

Bank Of Spain Governor De Cos: No Signs Of New Property Bubble In Spain – RTRS ( @LiveSquawk )

It is hard not to think of the “Never believe anything until it is officially denied” by the apocryphal prime minister Jim Hacker at this point. He is responding to this covered by El Pais yesterday.

The International Monetary Fund (IMF) is calling on Spain to monitor the price of real estate following a rebound of the property market after years of crisis. After analyzing late 2017 statistics, the global agency has detected early signs of “a slight overvaluation,” although it stressed that there is still nothing like a new housing bubble in Spain.

Here is a reminder of the state of play which is that Spain is a nation of home owners.

The IMF finds that house prices increased by around 15% between 2014 and 2017, but that sales are being driven by existing housing stock rather than new housing. Another change from pre-crisis days is that the home ownership rate has dropped from 80% to 77% as people increasingly turn to the rental market.

Let us bring the numbers up to date via INE from the end of last week.

The annual variation of the Housing Price Index (IPV) in the third quarter of 2018 increases four tenths and stands at 7.2%……The quarterly variation of the general IPV in the third quarter of 2018 is 2.2%.

The IMF seems to have missed that the pace of house price growth has picked up in Spain. Not only the 2.2% quarterly rise but the fact that the overall index set at 100 in 2015 is now at 120.5. Returning to the role of the ECB a typical mortgage rate (over 3 years) is 1.93%.

Ireland

Last time around a housing boom and later bust in Spain was accompanied by one in Ireland so let us check in on yesterday’s official update.

Residential property prices increased by 8.4% nationally in the year to October. This compares with an increase of 8.5% in the year to September and an increase of 11.7% in the twelve months to October 2017.

As you can see the heat is on again and is heading towards levels which caused so much trouble last time around.

Overall, the national index is 17.6% lower than its highest level in 2007. Dublin residential property prices are 20.1% lower than their February 2007 peak, while residential property prices in the Rest of Ireland are 22.7% lower than their May 2007 peak.

Also they have got there rather quickly.

Property prices nationally have increased by 83.8% from their trough in early 2013. Dublin residential property prices have risen 98.0% from their February 2012 low, whilst residential property prices in the Rest of Ireland are 77.9% higher than at the trough, which was in May 2013.

Now that it has got the central banking holy grail of higher house prices the ECB seems to have, for some reason got cold feet about putting them in the consumer inflation index.

The ECB concludes that the integration of the OOH price index would deteriorate the current
frequency and timeliness of the HICP, and would introduce an asset element. Against this
background, it takes the view that the OOH price index is in practice not suitable for
integration into the official HICP.

It has turned into a classic bureaucratic move where you promise something have a committee formed to do it which concludes so sadly that it will not do it. The reasons stated were known all along.

Economic growth

Whilst house price developments will put a smile on the faces of Governing Council members other economic developments may wipe that smile away. One possible bright spot has gone a bit dark. From France24.

 

The Bank of France said the Eurozone’s second-biggest economy would eke out growth of only 0.2% in the three months to December, down from 0.4% in a previous estimate and from that rate in the third quarter.

“Services activity has slowed under the impact of the movement. Transport, the restaurant and auto repair sectors have gone backwards,” the bank said in its latest company survey.

The forecast is well short of the 0.8% that would be needed to meet the government’s 2018 growth target of 1.7%.

That was reinforced by the production and manufacturing data for October which was up on the month but 0.1% lower than a year ago. The growth shortfall will only make the next French problem worse. From Reuters.

Macron announced wage increases for the poorest workers and a tax cut for most pensioners on Monday to defuse discontent, leaving his government scrambling to come up with extra budget savings or risk blowing through the EU’s 3 percent of GDP limit.

That is especially awkward considering how vocal the French government had been about the Italian budget plans which in percentage terms was set to be a fair bit smaller.

Italy

The perennial under performer in economic terms seems to be in yet another “girlfriend in a coma” style phrase. From the latest monthly economic report.

In Italy, the GDP decreased marginally in the third quarter due to a contraction in both gross fixed investments and private consumption. On the contrary, the net exports contributed positively to growth.

The employment stabilized on past months levels recording a re-composition, which favored full time employees. Unemployment rate increased and was complemented by a reduction in inactive persons.

Italian inflation continued to be lower than the Eurozone average but the gap is closing.
In November, both the consumer confidence and the composite indicators decreased. The leading indicator stabilized on past months minimum values confirming the business cycle weakness.

There is a genuine danger of what some of the media have decided to call a technical recession. I get the point about it being within the margin of error and applaud their sudden conversion to this cause. But missing from this is the fact that this is an ongoing depression in Italy which shows not only no sign of ending but may be getting worse.

Comment

This will be a meeting of two halves. The awkward part is that after all the extraordinary monetary action involving negative interest-rates, QE and credit easing the Euro area economy has slowed from a quarterly growth rate of 0.7% to 0.2%. If we were not where we are the ECB would be discussing a stimulus programme. Except of course the plan is to announce the end to monthly QE bond purchases. Some places are suggesting a delay to future interest-rate increases as they catch up with my long-running view that Mario Draghi has no intention of raising them on his watch.

The second half will be the one emphasised which is that the ECB has hit its inflation target.

Euro area annual inflation is expected to be 2.0% in November 2018, down from 2.2% in October 2018, according to a flash estimate from Eurostat.

Okay not the 1.97% level defined by the previous President Jean-Claude Trichet but close enough. I wonder if any of the press corps will have the wit to ask about the U-Turn on including house prices in the inflation measure and whether that is because monetary policy can inflate house prices?

 

 

 

 

 

The challenge for the ECB remains Italy and its banks

This week has seen something of an expected shifting of the sands from the European Central Bank ( ECB) about the economic prospects for the Euro area. On Monday its President Mario Draghi told the European Parliament this.

The data that have become available since my last visit in September have been somewhat weaker than expected. Euro area GDP grew by 0.2% in the third quarter. This follows growth of 0.4% in both the first and second quarter of 2018. The loss in growth momentum mainly reflects weaker trade growth, but also some country and sector-specific factors.

What he did not say was that back in 2017 quarterly growth had risen to 0.7% for a time. Back then the situation was a happy one for Mario and his colleagues as their extraordinary monetary policies looked like they were bearing some fruit. However the challenge was always what happens when they begin to close the tap? Let me illustrate things by looking again at his speech.

The unemployment rate declined to 8.1% in September 2018, which is the lowest level observed since late 2008, and employment continued to increase in the third quarter…….. Wages are rising as labour markets continue to improve and labour supply shortages become increasingly binding in some countries.

There is a ying and yang here because whilst we should all welcome the improvement in the unemployment rate, we would expect the falls to slow and maybe stop in line with the reduced economic growth rate. So is around 8% it for the unemployment rate even after negative interest-rates ( still -0.4%) and a balance sheet now over 4.6 trillion Euros? That seems implied to some extent in talk of “labour supply shortages” when the unemployment rate is around double that of the US and UK and treble that of Japan. This returns us to the fear that the long-term unemployment in some of the Euro area is effectively permanent something we looked at during the crisis. In another form another ECB policymaker has suggested that.

I will focus my remarks today on the economies of central, eastern and south-eastern Europe (CESEE), covering both those that are already part of the European Union (EU) and those that are EU candidate countries or potential candidates………..Clearly, for most countries, convergence towards the EU-28 average has practically stalled since the outbreak of the financial crisis in 2008

Care is needed as only some of these countries are in the Euro but of course some of the others should be converging due to the application process. Even Benoit Coeure admits this.

And if there is no credible prospect of lower-income countries catching up soon, there is a risk that people living in those countries begin questioning the very benefits of membership of the EU or the currency union.

I have a couple of thoughts for you. Firstly Lithuania has done relatively well but the fact I have friends from there highlights how many are in London leading to the thought that how much has that development aided its economy? You may need to probe a little as due to the fact it was part of Russia back in the day some prefer to say they are Russian. Also the data reminds us of how poor that area that was once called Yugoslavia remains. It is hardly going to be helped by the development described below by Balkan Insight.

At the fifth joint meeting of the governments of Albania and Kosovo in Peja, in Kosovo, the Albanian Prime Minister Edi Rama backed the decision of the Kosovo government to raise the tax on imports from Serbia and Bosnia from 10 to 100 per cent.

Banks

Here the ECB is conflicted. Like all central banks its priority is “the precious” otherwise known as the banks. Yet it is part of the operation to apply pressure on Italy and take a look at this development.

As this is very significant let us break it down and yes in the world of negative interest-rates and expanded central bank balance sheets Unicredit has just paid an eye-watering 7.83% on some bonds. Just the 6.83% higher than at the opening of 2018 and imagine if you held similar bonds with it. Ouch! Of that there is an element driven by changes in Italy’s situation but the additional part added by Unicredit seems to be around 3.5%.

If we look back I recall describing Unicredit as a zombie bank on Sky News around 7 years ago. The official view in more recent times is that it has been a success story in the way it has dealt with non performing loans and the like. Although of course success is a relative term with a share price of 11.5 Euros as opposed to the previous peak of more like 370 Euros. Now it is paying nearly 8% for its debt we need not only to question even that heavily depreciated share price and it gives a pretty dreadful implied view for the weaker Italian banks such as Monte Paschi which Johannes mentions. Also those non-performing loans which were packaged up and sold at what we were told “great deals” whereas now they look dreadful, well on the long side anyway.

Perhaps this was what the Bank of Italy meant by this.

The fall in prices for Italian government securities has caused a reduction in capital reserves and
liquidity and an increase in the cost of wholesale funding. The sharp decline in bank share prices has resulted
in a marked increase in the cost of equity. Should the tensions on the sovereign debt market be protracted, the
repercussions for banks could be significant, especially for some small and medium-sized banks.

Comment

We can bring things right up to date with this morning’s money supply data.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 6.8% in October, unchanged from previous month.

So we are holding station to some extent although in real terms we are slightly lower as inflation has picked up to 2.2%. Thus the near-term outlook remains weak and we can expect a similar fourth quarter to the third. Actually I would not be surprised if it was slightly better but still weak..

Looking around a couple of years ahead the position is slightly better although we do not know yet how much of this well be inflation as opposed to growth.

Annual growth rate of broad monetary aggregate M3 increased to 3.9% in October 2018 from 3.6% in September (revised from 3.5%).

On the other side of the coin credit flows to businesses seem to have tightened.

Annual growth rate of adjusted loans to non-financial corporations decreased to 3.9% in October from 4.3% in September

Personally I think that the latter number is a lagging indicator but the ECB has trumpeted it as more of a leading one so let’s see.

The external factor which is currently in play is the lower oil price which will soon begin to give a boost and will reduce inflation if it remains near US $60 for the Brent Crude benchmark. But none the less the midnight oil will be burning at the ECB as it mulls the possibility that all that balance sheet expansion and negative interest-rates gave economic activity such a welcome but relatively small boost. Also it will be on action stations about the Italian banking sector. For myself I fear what this new squeeze on Italian banks will do to the lending to the wider economy which of course had ground to a halt as it is.

 

What just happened to the GDP and economy of France?

Sometimes reality catches up with you quite quickly so this morning Mario Draghi may not want a copy of any French newspapers on holiday. This is because on the way to one of the shorter and maybe shortest policy meeting press conferences we were told this.

The latest economic indicators and survey results have stabilised and continue to point to ongoing solid and broad-based economic growth, in line with the June 2018 Eurosystem staff macroeconomic projections for the euro area.

As you can see below Mario did drift away from this at one point but then returned to it in the next sentence.

Some sluggishness in the first quarter is continuing in the second quarter. But I would say almost all indicators have now stabilised at levels that are above historical averages.

Then we got what in these times was perhaps the most bullish perspective of all.

Now, one positive development is the nominal wage performance where, you remember, we’ve seen a pickup in nominal wage growth across the eurozone. Until recently this pickup was mostly produced by wage drift, while now we are seeing that there is a component, which is the negotiated wage component, which is now – right now the main driver of the growth in nominal wages.

Most countries have a sustained pick up in wage growth as a sort of economic Holy Grail right now. So we were presented with a bright picture overall and as I pointed out yesterday Mario is the master of these events as he was even able to make a mistake about economic reforms by saying there had been some, realise he had just contradicted what is his core message and engage reverse  gear apparently unnoticed by the press corps.

France

This morning brought us to the economic growth news from France which we might have been expecting to be solid and broad-based and this is what we got.

In Q2 2018, GDP in volume terms* rose at the same pace as in Q1: +0.2%

Now that is not really solid especially if we recall it is supposed to be above historical averages so let us also investigate if it is broad-based?

Household consumption expenditure faltered slightly in Q1 2018 (−0.1% after +0.2%): consumption of goods declined again (−0.3% after −0.1%) and that of services slowed down sharply (+0.1% after +0.4%).

The latter slowdown is concerning as we note that estimates put the services sector at just under 79% of the French economy. We also might expect better consumption data as whilst it may be a bit early for Mario’s wages growth claims to be at play household disposable income rose by 2.7% in 2017. However such metrics seem to have dropped a fair bit so far this year as household purchasing power was estimated to have fallen by 0.6% in the opening quarter of this year. So if anything is broad-based here it is the warning about a slowdown we got a few months ago and not the newer more upbeat version.

Trade

This was a drag on growth but not in the way you might expect. The easy view would be that French car exports would have been affected by the trade wars developments. But whilst there nay be elements of that it was not exports which were the problem.

Imports recovered sharply in Q2 2018 (+1.7% after −0.3%) after the decrease observed in Q1. Exports also bounced back but to a lesser extent (+0.6% after −0.4%). All in all, foreign trade balance contributed negatively to GDP growth: −0.3 points after a neutral contribution in the previous quarter.

That is a bit like the UK in the first quarter and we await developments as even quarterly trade figures can be unreliable.

Production

Production in goods and services barely accelerated in Q2 2018 (+0.2% after +0.1%)………….Output in manufactured goods fell back again (−0.2% after −1.0%). Production in refinery stepped back (−9.9% after −1.6%) due to technical maintenance; production in electricity and gas dropped too (−1.7% after +1.9%). However, construction bounced back (+0.6% after −0.3%).

As you can see there is not a lot to cheer here as construction may just be correcting the weather effect in the first quarter. There was better news from investment though.

In Q2 2018, total GFCF recovered sharply (+0.7% after +0.1% in Q1 2018), especially because of the upsurge in corporate investment (+1.1% after +0.1%). It was mainly due to the upswing in manufactured goods (+1.2% after −1.1%)

As there was not much of a sign of a manufacturing upswing lets us hope that the optimism ends up being fulfilled as other wise we seem set to see more of this.

Conversely, changes in inventories drove GDP on (+0.3 points after 0.0 points).

The Outlook

We of course are now keen to know how the third quarter has started and what we can expect next? From the official survey published on Tuesday.

The balances of industrialists’ opinion on overall and
foreign demand in the last three months have dropped
again sharply in July – they had reached at the beginning of the year their highest level in seven years, before dropping back in the April survey. Business managers are also less optimistic about overall and foreign demand over the next three months;

If we look at the survey index level the number remains positive overall but the direction of travel is south, not as bad as the credit crunch impact but more like how the Euro area crisis impacted which is odd. Let us now switch to the services sector.

According to business managers surveyed in July
2018, the business climate remains stable in services.
The composite indicator which measures it has stood at
104 since May 2018, above its long-term average
(100).

Is stable the new contraction? Perhaps if we allow for the rail strikes in the second quarter but the direction of travel has again been south. If we step back and look at the overall survey which has a long record we see that it recorded a pick up early in 2013 which had some ebbs and flows but the trend was higher and now we are seeing the first turn and indeed sustained fall.

I cannot find anything from the Markit PMI business surveys on this today as presumably they are mulling how they seem now to be a lagging indicator as opposed to a leading one.

Comment

The rhetoric of only yesterday has faded quite a bit as we mull these numbers from France. It is the second biggest economy in the Euro area and the story that if we use a rowing metaphor it caught a crab at the beginning of the year now seems untrue. It may even have under performed the UK which is supposed to be on a troubled trajectory of its own. Under the new structure we do not have the official numbers for June in the UK. The surveys quoted above do not seem especially optimistic apart from the Markit ones which of course have been through this phase.

A more optimistic view comes from the monetary data which as I analysed on Wednesday has stopped getting worse and strengthened in terms of broad money and credit. Let me give a nod to the masterful way Mario Draghi presented the narrow money numbers.

The narrow monetary aggregate M1 remained the main contributor to broad money growth. ( It fell…)

So the outlook should be a little better and the year on course for the 1.3% suggested by the average number calculated today. But 0.7%,0.7% to 0.2%,0.2% is quite a lurch.

In other news let me congratulate France on being the football World Cup winners. Frankly they have quite a team there. But in the language world cup there is only one winner as Mario Draghi went to some pains to point out yesterday.

Let me clear: the only version that conveys the policy message is the English version. We conduct our Governing Council in English and agree on an English text, so that’s what we have to look at.

Or as someone amusingly replied to me Irish……

Will Italy get a 250 billion Euro debt write-off from the ECB?

Up until now financial markets have been very sanguine about the coalition talks and arrangements in Italy. I thought it was something of calm before the storm especially as these days something which was a key metric or measure – bond yields – has been given a good dose of morphine by the QE purchases of the European Central Bank. However here is a  tweet from Ferdinando Guigliano  based on information from the Huffington Post which caught everyone’s attention.

1) Five Star and the League expect the to forgive 250 billion euros in Italian bonds bought via quantitative easing, in order to bring down Italy’s debt.

My first thought is that is a bit small as whilst that is a lot of money Italy has a national debt of 2263 billion Euros or 131.8% of its GDP or Gross Domestic Product according to Eurostat. So afterwards it would be some 2213 billion or 117% of GDP which does not seem an enormous difference. Yes it does bring it below the original 120% of GDP target that the Euro area opened its crisis management with but seems hardly likely to be an objective now as frankly that sank without trace. Perhaps they have thoughts for spending that sort of amount and that has driven the number chosen.

Could this happen?

As a matter of mathematics yes because the ECB via the Bank of Italy holds some 368 billion Euros and rising of Italian government bonds and of course rising. However this crosses a monetary policy Rubicon as this would be what is called monetary financing and that is against the rules and as we are regularly told by Mario Draghi the ECB is a “rules based organisation”. Here is Article 123 of the Lisbon Treaty and the emphasis is mine.

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

Now we hit what Paul Simon would call “troubled water” as the ECB has of course been very close to the highlighted part. The argument for QE purchases rested on the argument that buying in the secondary market was indirect and not direct or as the ECB puts it.

There will be no primary market purchases under the PSPP, regardless of the type of security, as such purchases are not allowed under Article 123 of the Treaty on the Functioning of the European Union.

It is a bit unclear as to when they become available but if I recall correctly as an example the Bank of England limit is one week.

The reason for this is to stop a national government issuing debt and the central bank immediately buying it would be a clear example of round-tripping. The immediate implication would be a higher money supply raising domestic inflation dangers  although there would be an initial boost to the economy. We did look at an example of this a couple of years ago in the case of Ghana and whilst we never get a test tube example in economics the Cedi then fell a substantial amount and inflation rose . Thus the two worrying implications are inflation and a currency plunge on a scale to cause an economic crisis.

Would this happen in the case of Italy? That depends on how it plays out. Inside the boundaries of the Euro maybe not to a  great extent initially but as it played out there would be an effect as Italy would not doubt be back for “More,More,More” once Pandora’s Box was open and of course others would want to get their fingers in the cookie jar.

Oh and if we go back to the concept of the ECB being a “rules based organisation” that is something that is until it breaks them as we have learnt over time.

Fiscal Policy

You will not be surprised to learn that they wish to take advantage of the windfall. Back to the tweets of Ferdinando Guigliano

5) The draft agreement would see the Italian government spend 17 billion euros a year on a “citizens’ income”. The European Commission would contribute spending 20% of the European Social Fund

That raises a wry smile as we mull the idea of them trying to get the European Commission to pay for at least some of this. Perhaps they are thinking of the example of Donald Trump and his wall although so far that has been more of a case of a “Mexicant” than a “Mexican.”

Next came this.

According to , the 5 Star/League draft document says there would be a “flat tax”… but with several tax rates and deductions

So flat but not flat well this is Italy! Also we see what has become a more popular refrain in this era of austerity.

Italy’s pension reform would be dismantled: workers would be able to retire when the sum of their retirement age and years of contribution is at least 100.

Over time this would be the most damaging factor as we get a drip feed that builds and builds especially at a time of demographic problems such as an aging population.

So a fiscal relaxation which would require some changes in the rules of the European Union.

The two parties want to re-open European Treaties and to “radically reform” the stability and growth pact. The coalition would also want to reconsider Italy’s contribution to the EU budget.

Market Response

That has since reduced partly because the German bond market has rallied. Partly that is luck but there is an odd factor at play here. You might think that as the likely paymaster of all this Germany would see its bonds hit but the reality is that it is seen as something of a safe haven which outplays the former factor. On that road it issued some two-year debt yesterday with investors paying it around 0.5% per annum. Also I think there is such a shock factor here that it takes a while for the human mind to take it in especially after all the QE anaesthetic.

The Euro has pretty much ignored all of this as I use the rate against the Yen as a benchmark and it has basically gone “m’eh” as has most of the others so far.

Comment

There are quite a few factors at play here and no doubt there will be ch-ch-changes along the way. But the rhetoric at least has been raised a notch this morning.

We are in favor of a consultative referendum on the euro. It might be a good idea to have two euros, for two more homogeneous economical regions. One for northern Europe and one for southern Europe. ( Beppe Grillo in Newsweek)

I do not that the BBC and Bloomberg have gone into overdrive with the use of the word “populists” as I mull how you win an election otherwise? If we stick to our economics beat this is plainly a response of sorts to the ongoing economic depression in Italy in the Euro era. Also it was only on Monday when the Italian head of the ECB was asking for supra national fiscal policy. For whom exactly? Now we see Italy pushing for what we might call more fiscal space.

Meanwhile if we look wider we see yet more evidence of an economic slow down in 2018 so far.

Japan GDP suffers first contraction since 2015

Very painful for the Japanese owned Financial Times to print that although just as a reminder Japan is one of the worst at producing preliminary numbers.

Where next for the Euro exchange-rate?

As we start a new week the focus will be shifting to the Euro area and its economy and exchange-rate. The reason for this comes from my article of last Wednesday which concluded with this.

The ECB finds itself in something of a dilemma. This is because it has continued with a highly stimulatory policy in a boom and now faces the issue of deciding if the current slow down is temporary or not? Even worse for presentational purposes it has suggested it will end QE in September just in time for the economic winds to reverse course.

Such thoughts were strongly reinforced in the Thursday press conference when we started with an Introductory Statement mentioning moderation.

Following several quarters of higher than expected growth, incoming information since our meeting in early March points towards some moderation, while remaining consistent with a solid and broad-based expansion of the euro area economy

At this point we merely have the ECB Governing Council covering itself either way as if they economy picks-up they will emphasis the latter bit and if it slows down they will tell us they warned about moderation. But then in his replies to questions President Draghi took things a step or two further.

 It’s quite clear that since our last meeting, broadly all countries experienced, to different extents of course, some moderation in growth or some loss of momentum. When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

As I pointed out on Friday if we translate from the language of central bankers the use of “significant sharp declines” is of importance as these days they consider it their job to stop that! If you had negative interest-rates and a balance sheet of over 4.5 trillion Euros it would give you food for thought. If we look at the next bit we can see that it did as it occupied so much time they did not discuss monetary policy at all.

 First of all, the interesting thing is that we didn’t discuss monetary policy per se. All Governing Council members reported on the situation of their own countries.

So they decided that as there is nothing they can do in the short-term and policy is already expansionary there was nothing to do. Also they were again caught on the hop.

And these declines were sharp and in some cases, the extent of these declines was unexpected.

Today’s monetary data

This will have attracted the attention of Mario Draghi and the Governing Council so let us start with the headline.

The annual growth rate of the broad monetary aggregate M3 decreased to 3.7% in March 2018,
from 4.2% in February.

Now let us compare it with the press conference Introductory Statement.

Turning to the monetary analysis, broad money (M3) continues to expand at a robust pace, with an annual growth rate of 4.2% in February 2018, slightly below the narrow range observed since mid-2015.

If we look through the rhetoric we see that it was already below the range that had led to the recent stronger economic growth. If we use the rule of thumb that broad money growth can be divided between economic growth and inflation we see that one of them will be squeezed. With the price of a barrel of Brent Crude Oil remaining around US $74 per barrel it seems that there will be upwards pressure on inflation from this source which may further squeeze output.

In terms of the immediate future then it is narrow money which gives us the best guide and it too was a disappointment.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation and overnight deposits, decreased to 7.5% in March, from 8.4% in February.

This series peaked at just under 10% last autumn so we can see that from it we will be expecting something of a slow down over the next 6 months or so.

Is this the impact of QE?

The impact on March may well be the consequence of the reduction in monthly QE purchases from 60 billion Euros a month to 30 billion which began in January. The monthly numbers for M1 growth have gone 51 billion, 31 billion and now 20 billion so whilst it is not that simple as the numbers are erratic I think it added to an existing trend.

This leaves the ECB mulling the irony that it chose to do less as the economy weakened. Or that the expansion needs a continuous dose of the economic pick me up and cannot thrive otherwise.

What about credit?

When you consider that the taps are supposed to be fully open it was not that special.

The annual growth rate of total credit to euro area residents decreased to 2.9% in March 2018, compared
with 3.4% in the previous month.

Whilst it may not look like it from the number above but March was better than February if you look into the detail such as this one.

In particular, the annual growth rate of adjusted loans to households increased to 3.0% in March, from 2.9% in February, and the annual growth rate of adjusted loans to non-financial corporations increased to 3.3% in March, from 3.2% in February.

But such numbers are more of a lagging indicator than a leading one so we are left with a downbeat view.

Comment

In terms of first quarter data the score is 2-1. On the downside we have seen GDP ( Gross Domestic Product) growth in Belgium dip to 0.4% and more of a fall in France to 0.3%. On the other side Spain shrugged it off and grew by 0.7%. As even the German Bundesbank is expecting a slow down there it seems set to be a weaker quarter for Euro area growth and that will not have been helped by the weakness in the UK.

This means that two of the supports for the level of the Euro are weakening. The first is the fading and perhaps end of the Euroboom as the better economic growth data supported the currency. The second is a potential consequence which is the planned reduction in QE in September where eyes will soon turn to this bit from the ECB.

are intended to run until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.

Actually the inflation issue is also on the cards today after this from Italy.

In April 2018, according to preliminary estimates, the Italian consumer price index for the whole nation (NIC) increased by 0.1% on monthly basis and by 0.5% compared with April 2017.

So a long way from the just below 2% objective and Portugal at 0.3% was similar. Whilst I expect the new higher oil price to change things we could see a shake-up in the plans for QE in 2018. Whilst we know it is nor as simple as more QE or more negative interest-rates equals a weaker currency a shift like that seems likely to have an effect.

Meanwhile as ever life is complex as according to the oil trader @chigrl a higher oil price boosts the value of the Euro.

Thus the foreign currency reserve balances of these oil exporting countries, in a sense, is broadly reflected by the price of oil. ……However, data also shows that they invest part of their reserves in EUR, as they sell a large share of their production to the Eurozone.

Which leads to this.

Thus, when the price of oil falls, this means that a smaller portion of USD is transferred to EUR, thus contributing to a depreciation of the currency. Inversely, when the price of oil increases, a larger portion is transferred to EUR, contributing to the appreciation of the currency.

This gets exacerbated when some try to game this.

For this reason, many funds lock their positions in EUR/USD with those in crude oil.

 

There are economic consequences of Brexit for the Euro area too

After looking mostly over the past few days about the likely economic future for the UK post Brexit it is time to widen the perspective and look at the implications more widely in Europe. As it and the UK go through a phase of what Chris Martin and Gwyneth Paltrow described as “consciously uncoupling” there are many implications across Europe. This was on the mind of ECB ( European Central Bank) President Mario Draghi yesterday as he spoke at its summer conference at Sintra Portugal. We do not know if he toasted absent friends as US Federal Reserve Chair Janet Yellen and Bank of England Governor Mark Carney were late withdrawals from summer camp. So no chianti and chat with Mario this summer for them!

Mario wants alignment

The speech was revealing in the fact that whilst it explicitly avoided the word Brexit there was an implicit theme which addressed it. Let me explain.

So we have to think not just about whether our domestic monetary policies are appropriate, but whether they are properly aligned across jurisdictions.

This is quite a shift if you think about it. There was talk of aligning policy around currencies earlier this year but of course we have large economies both explicitly ( Japan) and implicitly ( China and the Euro area) trying to push their currencies lower. If we stay with the Euro area some would argue that the 80 billion Euros a month of QE and an official interest-rate of -0.4% have contributed to its fall. It’s trade-weighted exchange-rate has fallen from 104.5 in April 2014 to 94.43 now with the Brexit impact being around 0.5 of that. Just to explain whilst the Euro has risen against the UK Pound £ it fell against the US Dollar.

Still we do have a fall of the size Mario discussed in 2014.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

So he thinks it has raised inflation by circa 0.5% but you note that he does not mention economic growth here. That is because currency depreciations are very awkward for an economic entity which consistently posts current account surpluses.

The current account of the euro area showed a surplus of €329.5 billion (3.2% of euro area GDP) in 2015

After noting such factors it is hard to avoid the view that the phrase “exporting deflation” applies to the Euro area overall. Other nations and trading blocs may well be not entirely keen on “alignment” after the Euro area has already moved some chess pieces in its favour.

Globalisation

There was a clear attempt by Mario to shift the debate to world issues.

What I am saying here is that the same applies at the global level. We may not need formal coordination of policies. But we can benefit from alignment of policies. What I mean by alignment is a shared diagnosis of the root causes of the challenges that affect us all; and a shared commitment to found our domestic policies on that diagnosis.

There are various problems here as I have just pointed out. How can the Euro fall against the Yen or Yuan whilst they are falling against it for example? In fact Mario Draghi sounds rather like he has borrowed the TARDIS of Dr.Who and jumped back to 2008 to talk to Martin Wolf of the Financial Time and Bank of England Governor Mervyn King ( he wasn’t a Baron back then).

Indeed, to the extent that the environment in which we operate is more affected by the global output gap, and the global savings-investment balance, the speed with which monetary policy can achieve domestic goals inevitably becomes more dependent on others – on the success of authorities in other jurisdictions to also close their domestic output gaps; and on our collective ability to tackle the secular drivers of global saving and investment imbalances.

Is Mario singing along with Lilly Allen “It’s not me it’s you” and “It’s not fair”? Also you may note that he is agreeing with one of my themes which is that the credit crunch provided the coup de grace to “output gap” theories. He would not put it like that but you see it has now failed in countries ( UK for example) and now apparently we are told by default in the Euro area so now we have a world one! Please just think through the implications of that and let me offer just one. How would you possibly ever measure it?

Downbeat forecasts

As ever the more private thoughts meet a leaky vessel and let us hope that unlike in the past hedge funds were not given an “early wire” to this. But Bloomberg have picked up on some details.

Draghi sees cutting Euro GDP by as much as 0.5%, document shows

That is a little vague as there were mentions of three years and others used the word growth as we wait to see if that is total or annual. But there was more to come.

Draghi Warns Brexit Will Lead To “Competitive Devaluations”

I wonder if he managed to say that with a straight face! Also I note that the Brexit purdah did not last long. However there is more.

ECB’s Draghi: Concerned Brexit will lead to competitive devaluations, says its time to address bank vulnerabilities ( @DailyFXTeam )

The latter bit caught my eye as we have been told for the last 8 years or so that the ECB has been on the case of reforming the banks and time and time again we have been told that they are “resilient”, yet vulnerable is apparently the new resilient. Every ECB press conference Mario Draghi speaks about economic reform and each month it is the same groundhog day style statement. This if course comes back to the issue of how you can ever reform banks that know they will be bailed out?

The Italian banks

There is an obvious problem here as resilience morphs into vulnerabilities like the 360 billion Euros of sour loans at the Italian banks. This is a fast-moving situation where it appears that Italy has been informed that an outright bailout breaks the new Euro area banking rules. I am grateful to @liukzilla for pointing out that the vehicle below might be used.

CDP MAY HAVE ROLE IN BANKS CAPITAL RAISING: REPUBBLICA……yep, Cassa Depositi e Presiti

This is 80% owned by the state and seems at first sight to be an effort similar to Portugal where you help the banks but try to keep it off the national debt numbers. For now we seem to be left with the bad bank Atlante which cannot have much more of its 4.25 billion Euros left.  The problem with other banks putting money into it is that they are weakened too and this is similar if not the same to the way that some of the cajas in Spain hit trouble.

Any large-scale move here seems set to blast a hole in the Euro area banking union rules and post questions for the whole concept of it.

Comment

So we see one of the reasons for the equity market rally or what is called “risk-on”. There is no explicit “whatever it takes” phrase but Mario Draghi is hinting at yet more asset purchases. So we have a type of Mario “Put Option” for the equity markets. The danger is that he ends up turning fully Japanese and we end up with a Frankfurt Whale competing with the Tokyo Whale. The play King Lear has the image of a little old lady turning the wheel of fortune well each turn of this particular wheel is one more nail in the coffin of the concept of price discovery as instead markets front-run central banks.

Meanwhile we have gone beyond a drum beat and a bass line to a full orchestra playing one of the longest running themes of my work.

Since Thursday, global stock of negative-yielding debt has jumped $1 trillion to just under $11trn, says BAML ( Chris_Whittall )

There is more.

Global 10y sovereign bond yields tumble to record low 0.5826% after Brexit, according to Citi. ( @ReutersJamie )

I still remember going to a UK “think-tank” around 5 years ago and warning about this and noting it hit home. But everybody apart from me then forgot about it.