The ECB “taper” meets “To infinity! And beyond!”

Yesterday was central banker day when we heard from Mark Carney of the Bank of England, Mario Draghi of the ECB and Janet Yellen of the US Federal Reserve. I covered the woes of Governor Carney yesterday and note that even that keen supporter of him Bloomberg is now pointing out that he is losing the debate. As it happened Janet Yellen was also giving a speech in London and gave a huge hostage to fortune.

Yellen today: “Don’t see another crisis in our lifetimes” Yellen May 2016: “We Didn’t See The Financial Crisis Coming” ( @Stalingrad_Poor )

Let us hope she is in good health and if you really wanted to embarrass her you would look at what she was saying in 2007/08. However the most significant speech came at the best location as the ECB has decamped to its summer break, excuse me central banking forum, at the Portuguese resort of Sintra.

Mario Draghi

As President Draghi enjoyed his morning espresso before giving his keynote speech he will have let out a sigh of relief that it was not about banking supervision. After all the bailout of the Veneto Banks in Italy would have come up and people might have asked on whose watch as Governor of the Bank of Italy the problems built up? Even worse one of the young economists invited might have wondered why the legal infrastructure covering the Italian banking sector is nicknamed the “Draghi Laws”?

However even in the area of monetary policy there are problems to be faced as I pointed out on the 13th of March.

It too is in a zone where ch-ch-changes are ahead. I have written several times already explaining that with inflation pretty much on target and economic growth having improved its rate of expansion of its balance sheet looks far to high even at the 60 billion Euros a month due in April.

Indeed on the 26th of May I noted that Mario himself had implicitly admitted as much.

As a result, the euro area is now witnessing an increasingly solid recovery driven largely by a virtuous circle of employment and consumption, although underlying inflation pressures remain subdued. The convergence of credit conditions across countries has also contributed to the upswing becoming more broad-based across sectors and countries. Euro area GDP growth is currently 1.7%, and surveys point to continued resilience in the coming quarters.

That simply does not go with an official deposit rate of -0.4% and 60 billion Euros a month of Quantitative Easing. Policy is expansionary in what is in Euro area terms a boom.

This was the first problem that Mario faced which is how to bask in the success of economic growth whilst avoiding the obvious counterpoint that policy is now wrong. He did this partly by indulging in an international comparison.

since January 2015 – that is, following the announcement of the expanded asset purchase programme (APP) – GDP
has grown by 3.6% in the euro area. That is a higher growth rate than in same period following QE1 or QE2 in the United States, and a percentage point lower than the period after QE3. Employment in the euro area has also risen by more than four million since we announced the expanded APP, comparable with both QE2 and QE3 in the US, and considerably higher than QE1.

You may note that Mario is picking his own variables meaning that unemployment for example is omitted as are differences of timing and circumstance. But on this road we got the section which had an immediate impact on financial markets.

The threat of deflation is gone and reflationary forces are at play.

So we got an implicit admittal that policy is pro-cyclical or if you prefer wrong. A reduction in monthly QE purchases of 20 billion a month is dwarfed by the change in circumstances. But we have to be told something is happening so there was this.

This more favourable balance of risks has been already reflected in our monetary policy stance, via the adjustments we have made to our forward guidance.

You have my permission to laugh at this point! If he went out into the streets of Sintra I wonder how many would know who he is let alone be running their lives to the tune of his Forward Guidance!? Whilst his Forward Guidance has not been quite the disaster of Mark Carney the sentence below shows a misfire.

This illustrates that core inflation does not
always give us a clear reading of underlying inflation dynamics.

The truth is as I have argued all along that there was no deflation threat in terms of a downwards spiral for inflation because it was driven by this.

Oil-related base effects are also the main driver of the considerable volatility in headline inflation that we have seen, and will be seeing, in the euro area………. As a result, in the first quarter of 2017, oil-sensitive items  were still holding back core inflation.

I guess the many parts of the media which have copy and pasted the core inflation/deflation theme will be hoping that their readers have a bout of amnesia. Or to put it another way that Mario has set up a straw (wo)man below.

What is clear is that our monetary policy measures have been successful in avoiding a deflationary spiral and securing the anchoring of inflation expectations.

Actually if you look elsewhere in his speech you will see that if you consider all the effort put in that in fact his policies had a relatively minor impact.

Between 2016 and 2019 we estimate that our monetary policy will have lifted inflation by 1.7 percentage points,
cumulatively.

So it took a balance sheet of 4.2 trillion Euros ( and of course rising as this goes to 2019) to get that? You can look at the current flow of 60 billion a month which makes it look a little better but it is not a lot of bang for your Euro.

Market Movements

There was a clear response to the mention of the word “reflationary” as the Euro rose strongly. It rose above 1.13 to the US Dollar as it continued the stronger  phase we have been seeing in 2017 as it opened the year more like 1.04.  Also government bond yields rose although the media reports of “jumps” made me smile as I noted that the German ten-year yield was only 0.4% and the two-year was -0.57%! Remember when the ECB promised it was fixing the issue of demand for German bonds?

Comment

On the surface this is a triumph for Forward Guidance as Mario’s speech tightens monetary policy via higher bond yields and a higher value for the Euro on the foreign exchanges. Yet if we go back to March 2014 he himself pointed out the flaw in this.

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

You see the effective or trade-weighted index dipped to 93.5 in the middle of April but was 97.2 at yesterday’s close. If we note that Mario is not achieving his inflation target and may be moving away from it we get food for thought.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

So as the markets assume what might be called “tapering” ( in terms of monthly QE purchases) or “normalisation” in terms of interest-rates we can look further ahead and wonder if “To infinity! And Beyond!” will win? After all if the economy slows later this year  and inflation remains below target ………

There are two intangible factors here. Firstly the path of inflation these days depends mostly in the price of crude oil. Secondly whilst I avoid politics like the plague it is true that we will find out more about what the ECB really intends once this years major elections are done and dusted as the word “independent” gets another modification in my financial lexicon for these times

 

The problems of the banks of Italy part 101

It is time to look again at a topic which is a saga of rinse and repeat. Okay I am not sure it is part 101 but it certainly feels like a never-ending story. Let us remind ourselves that the hands of the current President of the ECB ( European Central Bank) Mario Draghi are all over this situation. Why? Well let me hand you over to the ECB itself on his career so far.

1997-1998: Chair of the Committee set up to revise Italy’s corporate and financial legislation and to draft the law that governs Italian financial markets (also known as the “Draghi Law”)

It is a bit awkward to deny responsibility for the set of laws which bear you name! This happened during the period ( 1991-2001) that Mario was Director General of the Italian Treasury. After a period at the Vampire Squid ( Goldman Sachs) there was further career progression.

2006-October 2011Governor, Banca d’Italia

There were also questions about the close relationship and dealings between the Italian Treasury and the Vampire Squid over currency swaps.

https://ftalphaville.ft.com/2010/02/09/145201/goldmans-trojan-greek-currency-swap/?mhq5j=e2

But with Mario linking the Bank of Italy and the ECB via his various roles the latest spat in the banking crisis saga must be more than an embarrassment.

The inspection at Banca Popolare di Vicenza that began in 2015 was launched at the request of the Bank of Italy and was conducted by Bank of Italy personnel. Any subsequent decisions were not the responsibility of the Bank of Italy but of the European Central Bank, because in November 2014 Banca Popolare di Vicenza had become a ‘significant’ institution and was subject to the European Single Supervisory Mechanism (SSM). ( h/t @FerdiGiugliano )

So we can see that the Bank of Italy is trying to shift at least some of the blame for one of the troubled Veneto banks to the ECB. At this point Shaggy should be playing on its intercom system.

It wasn’t me…….It wasn’t me

An official denial

At the end of last month the Governor of the Bank of Italy gave us its Annual Report.

At the end of 2016 Italian banks’ non-performing loans, recorded in balance sheets net of write-downs, came to €173 billion or 9.4 per cent of total loans. The €350 billion figure often cited in the press refers to the nominal value of the exposures and does not take account of the losses already entered in balance sheets and is therefore not indicative of banks’ actual credit risk.

Indeed he went further.

Those held by intermediaries experiencing difficulties, which could find themselves obliged to offload them rapidly, amount to around €20 billion.

I suppose your view on this depends on whether you think that 20 billion Euros is a lot or a mere bagatelle. It makes you wonder why the problems at the Veneto banks and Monte Paschi seem to be taking so long to solve does it not?

Meanwhile he did indicate a route to what Taylor Swift might call “Trouble, trouble,trouble”.

At the current rate of growth, GDP would return to its 2007 level in the first half of the 2020s.

An economy performing as insipidly as that is bound to cause difficulties for its banks, but not so for the finances of its central bank.

The 2016 financial year closed with a net profit of €2.7 billion; after allocations to the ordinary reserve and dividends paid to the shareholders, €2.2 billion were allocated to the State, in addition to the €1.3 billion paid in taxes.

The QE era has seen a boom in the claimed profits for central banks and as you can see they will be very popular with politician’s as they hand them over cash to spend.

The ECB is pouring money in

The obvious problem with telling us everything is okay is that Governor Visco is part of the ECB which is pouring money into the Italian banks. From the Financial Times.

According to ECB data as of the end of April, Italian banks hold just over €250bn of the total long-term loans — almost a third of the total.

There is a counter argument that the situation where the Italian banks rely so much on the ECB has in fact simply kicked that poor battered can down the road.

“Some of them [Italian banks] are unprofitable even with the ECB’s cheap funding,” adds Christian Scarafia, co-head of Western European Banks at Fitch.

Fitch also observes that the TLTRO funding is tied up with Italy’s management of the non-performing loans that beset its banks. “The weak asset quality in Italy is certainly the big issue in the country and access to cheap ECB funding has meant that banks could continue to operate without having to address the asset quality problem in a more decisive manner,” says Mr Scarafia. (FT)

It was intriguing to note that the Spanish bank BBVA declared 36 million Euros of profits in April from the -0.2% interest-rate on its loans from the ECB. A good use of taxpayer backed money?

The Veneto Banks

For something that is apparently no big deal and according to Finance Minister Padoan has been “exaggerated” this keeps returning to the news as this from Reuters today shows.

Italian banks are considering assisting in a rescue of troubled lenders Popolare di Vicenza and Veneto Banca by pumping 1.2 billion euros (1.1 billion pounds) of private capital into the two regional banks, sources familiar with the matter said.

Good money after bad?

Italian banks, which have already pumped 3.4 billion euros into the two ailing rivals, had said until now that they would not stump up more money.

As you can see the ball keeps being batted between the banks, the state , and the Atlante fund which is a mostly private hybrid of bank money with some state support. Such confusion and obfuscation is usually for a good reason. A bail in has the problem of the retail depositors who were persuaded to invest in bank bonds.

Monte Paschi

On the 2nd of this month we were told that the problem had been solved and yet the saga like so many others continues on.

HEDGE FUND SAID IN TALKS TO BUY $270 MILLION MONTEPASCHI LOANS ( h/t @lemasabachthani )

Seems odd if it has been solved don’t you think? Mind you according to the FT the European Banking Authourity may have found a way of keeping it out of the news.

The EBA said it would be up to supervisors to decide whether to include any bank in restructuring within the stress tests, and European Central Bank supervisors have decided not to include Monte dei Paschi, people briefed on the matter said.

So bottom place is available again.

Comment

This has certainly been more of a marathon than a sprint and in fact maybe like a 100 or 200 mile race. The Italian establishment used to boast that only 0.2% of GDP was used to bailout Italian banks but of course it is now absolutely clear that this effort to stop its national debt rising even higher allowed the banking sector to carry on in the same not very merry way. This week the environment has changed somewhat with Santander buying Banco Popular for one Euro. Although of course the capital raising of 7 billion Euros needs to be factored into the equation. I guess Unicredit has troubles enough of its own and could not reasonably go for yet another rights issue!

Me on TipTV Finance

http://tiptv.co.uk/living-extraordinary-times-not-yes-man-economics/

 

The British and Irish Lions

I have been somewhat remiss in not wishing our players well on what is the hardest rugby tour of all which is a trip into the heart of the All Blacks. I am thoroughly enjoying it although of course we need to raise our game after a narrow win and a loss. Here’s hoping!

 

 

 

Will 2017 see an economic rennaisance for France?

This morning has opened with some better economic news for France as GDP ( Gross Domestic Product) growth was revised higher.

In Q1 2017, GDP in volume terms* rose barely less fast (+0.4%) than in Q4 2016 (+0.5%).

The French statistical service have put in it downbeat fashion and you have to read to the end to spot it as it is right at the bottom.

The GDP growth for Q1 2017 is raised from +0.3% to +0.4%.

There was also a good sign in the fact that investment was strong.

In Q1 2017, total GFCF accelerated sharply (+1.2% after +0.5%), especially that of enterprises (+1.9% after +0.9%)……Investment in manufactured goods was more dynamic (+1.6% after +0.4%), notably in equipment goods. Similarly, GFCF in market services accelerated sharply (+1.9% after +0.7%), notably in information-communication and business services.

However it was not a perfect report as there were signs of what you might call the British problem as trade problems subtracted from the growth.

Exports fell back in Q1 2017 (−0.8% after +1.0%), especially in transport equipment and “other manufactured goods”. Imports accelerated (+1.4% after +0.6%)………..All in all, foreign trade balance weighed down on GDP growth by −0.7 points, after a contribution of +0.1 points in the previous quarter.

If we look back there may be an issue building here as import growth was 4.2% in 2016 which considerably exceeded export growth at 2.1%. So it may well be true that the French are getting more like the British which is something of an irony in these times.

You may be wondering how there was any economic growth after the net trade deficit and that is because inventories swung the other way and offset it.

In Q1 2017, the contribution of changes in inventories to GDP growth amounted to +0.7 points (after −0.2 points at the end of 2016). They increased especially in transport equipment and “other industrial goods” (pharmaceuticals, metallurgy and chemicals).

The optimistic view on this is that French businesses are stocking up for a good 2017 with the danger being that any disappointment would subtract for growth later this year.

Also as feels so common in what we consider to be the first world the manufacturing industry continues to struggle.

Manufacturing output fell back (−0.2% after +0.7%), mainly due to a sharp decline in the coke and refined petroleum branch and a slowdown in transport equipment.

Looking ahead

The good news is that the private-sector business surveys are very optimistic at the moment.

The latest PMI data points to further strong growth momentum in the French private sector, with the expansion quickening to a six-year peak.

Of course France has been in a rough patch so that may not be as good as it reads or sounds so let us look further.

The service sector saw activity increase for the eleventh time in as many months. Moreover, the rate of expansion accelerated to a six-year high and was sharp overall. Manufacturing output also continued to rise markedly, albeit to a fractionally weaker extent than in April.

As you can see the service sector is pulling the economy forwards and manufacturing is growing as well according to the survey. Unusually Markit do not make a GDP prediction from this but we can if we note they think this for the Euro area which has a lower reading than France.

consistent with 0.6- 0.7% GDP growth.

So let us say 0.7% then and also remind ourselves that it has not been common in recent years for there to be an expectation that France will outperform its Euro area peers.

However this morning’s official survey on households did come with a worrying finale to the good news stream.

In May 2017, households’ confidence in the economic situation has improved anew after a four-month stability: the synthetic index has gained 2 points, reaching 102, above its long-term average and at its highest level since August 2007.

What could go wrong?

Unemployment

This has been the Achilles heel for France in the credit crunch era but this too has seen some better news.

In Q1 2017, the average ILO unemployment rate in metropolitan France and the overseas departments (excluding Mayotte) stood at 9.6% of active population, after 10.0% in Q4 2016.

The good news is that we see the unemployment rate finally fall into single digits. The bad news is that it mostly seems to be people who have given up looking for work.

The activity rate of people aged 15-64 stood at 71.4% in Q1 2017. It decreased by 0.3 percentage points compared to the previous quarter and a year earlier.

The business surveys are optimistic that employment is now improving as we see here.

Bolstered by strong client demand, French private sector firms raised their staffing numbers in May, thereby continuing a trend that has been evident since November last year. Furthermore, the rate of job creation quickened to a 69-month high.

Monetary policy

Yesterday we heard from ECB ( European Central Bank ) President Mario Draghi and he opened with some bombast.

Real GDP in the euro area has expanded for 16 consecutive quarters, growing by 1.7% year-on-year during the first quarter of 2017. Unemployment has fallen to its lowest level since 2009. Consumer and business sentiment has risen to a six-year high,

You might be wondering about monetary policy after such views being expressed but in fact we got this.

For domestic price pressures to strengthen, we still need very accommodative financing conditions, which are themselves dependent on a fairly substantial amount of monetary accommodation.

Is that a Tom Petty style full speed ahead and “Damn The Torpedoes”? For now perhaps but there are two other influences. In terms of a tactical influence Mario Draghi will have noted the rise of the Euro since it bottomed versus the US Dollar in December last year and would prefer it to be lower than the 1.12 it has risen to. Also more strategically as we have discussed on here before he will be waiting for the Euro area elections to pass before making any real change of course in my opinion. That leaves us mulling once again the concept of an independent central banker as we note that economic growth is on the upswing in election year.

Thus France finds itself benefiting from 293.7 billion Euros of sovereign bond purchases meaning it can issue and be paid for it out to around the 6 years maturity and only pay 0.74% on ten-year bonds. This is a considerable help to the fiscal situation and the government. In addition there are the corporate bond purchases and the covered bond purchases to help the banks. The latter gets so little publicity for the 232 billion Euros on the ECB’s books. Plus we have negative interest-rates and a Euro exchange rate pushed lower.

Has monetary policy ever been so expansionary at this stage of the economic cycle?

House prices

There was some further news to warm the cockles of Mario Draghi’s heart this morning.

In Q1 2017, the prices of second-hand dwellings kept increasing: +1.9% compared to the previous quarter (provisional seasonally adjusted results). The increase is virtually similar for flats (+1.9%) and for houses (+1.8%).

Over a year, the increase in prices was confirmed and strengthened: +3.0% compared to Q1 2016 after +1.5% the quarter before.

Up until now we have seen very little house price inflation in France and whilst the rate is relatively low it does look to be on the rise which represents a clear change. If you add this to the house price rises in Germany that I analysed on the 8th of this month then the ECB will be pleased if first-time buyers will not be.

Comment

It looks as though France is in a better phase of economic growth. This is certainly needed as we look at the unemployment rate issue but there is also another factor as this from French statistics indicates.

 2016 (GDP growth unchanged, at +1.1% WDA), 2015 (−0.2 points at +1.0%) and 2014 (+0.3 points at +1.0%)

As you can see the annual rate of economic growth has been essentially 1% as we note something of a reshuffle in the timing. Indeed in spite of a better couple of quarters the current annual rate of economic growth in France is you guessed it 1%! Somehow 1% became the new normal as we wait and hope for better news as 2017 develops. Should we get that then at this stage of the cycle I fear we may then be shifting to how long can it last?!

 

 

Will rising bond yields mean ECB QE is To Infinity! And Beyond!?

Yesterday the ECB ( European Central Bank ) President Mario Draghi spoke at the European Parliament and in his speech were some curious and intriguing phrases.

Our current monetary policy stance foresees that, if the inflation outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council is prepared to increase the asset purchase programme in terms of size and/or duration.

I say that bit was curious because it contrasted with the other rhetoric in the speech as we were told how well things are going.

Over the last two years GDP per capita has increased by 3% in the euro area, which compares well with other major advanced economies. Economic sentiment is at its highest level in five years. Unemployment has fallen to 9.6%, its lowest level since May 2009. And the ratio of public debt to GDP is declining for the second consecutive year.

The talk of what I would call “More,More,More” is also a contrast to the December policy decision which went down the road of less or more specifically slower.

We will continue to purchase assets at a monthly pace of €80 billion until March. Starting from April, our net asset purchases will run at a monthly pace of €60 billion, and we will reinvest the securities purchased earlier under our programme, as they mature. This will add to our monthly net purchases.

There was another swerve from Mario Draghi who had written to a couple of MEPs telling them that a country leaving the Euro would have to settle their Target 2 balances ( I analysed this on the  23rd of January ) whereas now we were told this.

L’euro e’ irrevocabile, the euro is irrevocable

Of course Italian is his natural language bur perhaps also there was a message to his home country which has seen the rise of political parties who are against Euro membership.

Such words do have impacts on bond markets and yields but I was particularly interested in this bit. From @macrocredit.

DRAGHI SAYS ECB POLICY DOESN’T TARGET BOND SPREADS

A rather curious observation from someone who is effectively doing just that and of course for an establishment which trumpeted the convergence of bond yield spreads back before the Euro area crisis. Just to be clear which is meant here is the gap between the bond yield of Germany and other nations such as Spain or Italy. These days Mario Draghi seems to be displaying all the consistency of Arsene Wenger.

Oh and rather like the Bank of England he seems to be preparing himself for a rise in inflation.

As I have argued before, our monetary policy strategy prescribes that we should not react to individual data points and short-lived increases in inflation.

Spanish energy consumers may not be so sanguine!

Growing divergence in bond yields

The reality has been that recently we have seen a growing divergence in Euro area bond yields. This has happened in spite of the fact that the ECB QE ( Quantitative Easing) bond buying program has continued. As of the latest update it has purchased some 1.34 trillion Euros of sovereign bonds as well as of course other types of bonds. Perhaps markets are already adjusting to the reduction in the rate of purchases planned to begin on April 1st.

France

Ch-ch-changes here are right at the core of the Euro project which is the Franco-German axis. If we look back to last autumn we see a ten-year yield which fell below 0.1% and now we see one of 1.12%. This has left it some 0.76% higher than its German equivalent.

Care is needed as these are still low levels but politicians get used to an annual windfall from ,lower bond yields and so any rise will be unwelcome. It is still true that up to the five-year maturity France can borrow at negative bond yields but it is also true that a chill wind of change seems to be blowing at the moment. The next funding auction will be much more painful than its predecessor and the number below suggests we may not have to wait too long for it.

The government borrowing requirement for 2017 is therefore forecast to reach €185.4bn.

Italy

Here in Mario’s home country the situation is more material as the ten-year yield has risen to 2.36% or 2% over that of Germany. This will be expensive for politicians in the same manner as for France except of course the yield is more expensive and as the Italian Treasury confirms below the larger national debt poses its own demands.

The redemptions over the coming year are just under 216 billion euros (excluding BOTs), or some 30 billion euros more than in 2016, including approximately 3.3 billion euros in relation to the international programme. At the same time, the redemptions of currently outstanding BOTs amount to just over 107 billion euros, which is below the comparable amount in 2016 (115 billion euros) as a result of the policy initiated some years ago to reduce the borrowing in this segment.

The Italian Treasury has also noted the trends we are discussing today.

As a result of these developments, the yield differentials between Italian government securities and similar securities from other core European countries (in particular, Germany) started to increase in September 2016……. the final two months of 2016 have been marked by a significant increase in interest rates in the bond market in the United States,

Although we are also told this

In Europe, the picture is very different.

Anyway those who have followed the many debacles in this particular area which have mostly involved Mario Draghi’s past employer Goldman Sachs will note this next bit with concern.

Again in 2017, the transactions in derivatives instruments will support active portfolio management, and they will be aimed at improving the portfolio performance in the current market environment.

Should problems emerge then let me place a marker down which is that the average maturity of 6.76 years is not the longest.

Portugal

Here the numbers are more severe as Portugal has a ten-year yield of 4.24% and of course it has a similar national debt to economic output ratio to Italy so it is an outlier on two fronts. It need to raise this in 2017.

The Republic has a gross issuance target of EUR 14 billion to EUR 16 billion through both auctions and syndications.

To be fair it started last month but do you see the catch?

The size was set at EUR 3 billion and the new OT 10-year benchmark was finally priced at 16:15 CET with a coupon of 4.125% and a re-offer yield of 4.227%.

That is expensive in these times of a bond market super boom. Portugal has now paid off some 44% of its borrowings from the IMF but it is coming with an increasingly expensive kicker. Maybe that is why the European establishment wanted the IMF involved in its next review of Portugal’s circumstances.

Also at just over five years the average maturity is relatively short which would mean any return of the bond vigilantes would soon have Portugal looking for outside help again.

As of December 31, 2016 the Portuguese State direct debt amounted to EUR 236,283 million, decreasing 0.5% vis-à-vis the end of the previous month ( 133.4% of GDP).

Comment

Bond markets will of course ebb and flow but recently we have seen an overall trend and this does pose questions for several countries in the Euro area in particular. The clear examples are Italy and Portugal but there are also concerns elsewhere such as in France. These forces take time but a brake will be applied to national budgets as debt costs rise after several years when politicians will have been quietly cheering ECB policies which have driven falls. Of course higher inflation will raise debt costs for nations such as Italy which have index-linked stocks as well.

If we step back we see how difficult it will be for the ECB to end its QE sovereign bond buying program and even harder to ever reverse the stock or portfolio of bonds it has bought so far. This returns me to the issues I raised on January 19th.

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise?

Meanwhile with the ECB being under fire for currency manipulation ( in favour of Germany in particular) it is not clear to me that this from Benoit Coeure will help.

The ECB has no specific exchange rate target, but the single currency has adjusted as a consequence. Since its last peak in 2011, the euro has depreciated by almost 30% against the dollar. The euro is now at a level that is appropriate for the economic situation in Europe.

The Monte Paschi saga continues

Firstly let me wish you all a very Happy New Year as we approach the month of January. As we switch to an ongoing theme which has occupied on here for some years it is linked to something else in the news or rather what is called fake news. From the Financial Times earlier this morning.

In an interview with the Financial Times, Mr Pitruzzella, head of the Italian competition body since 2011, said EU countries should set up independent bodies — co-ordinated by Brussels and modelled on the system of antitrust agencies — which could quickly label fake news, remove it from circulation and impose fines if necessary.

“Post-truth in politics is one of the drivers of populism and it is one of the threats to our democracies,” Mr Pitruzzella said. “We have reached a fork in the road: we have to choose whether to leave the internet like it is, the wild west, or whether it needs rules that appreciate the way communication has changed. I think we need to set those rules and this is the role of the public sector.”

I am pleased about this as I gave some examples of past fake news only on the 22nd of this month.

*PADOAN: ITALIAN BANKS ARE NOT WEAK (January)

*PADOAN: PERCEPTION OF ITALIAN BANKING SYSTEM HEALTH `DISTORTED’ (July)

Oh and he was on CNBC in September.

Bailout for Italian banks has been ‘absolutely’ ruled out

So Mr.Pitruzzella can start with the past pronouncements of Italy’s Finance Minister! Once he has done that he can move onto the prime minister who has just departed. From Business Insider.

At the beginning of this year, Prime Minister Renzi said: “Today, the bank is healed, and investing in it is a bargain. [Monte dei Paschi] has been hit by speculation, but it is a good deal. It went through crazy vicissitudes, but today it is healed —it’s a good brand.

So both “healed” and “bargain” need to go into my financial lexicon for these times as we wonder how much of Matteo Renzi’s own money was invested?

The bailout or is it bail in?

Finance Minister Padoan ( who lest we forget was briefly  in the running to be the new prime minister) seems to be upset if someone points out his dissembling as this from Reuters highlights.

In unusually critical comments of the euro zone’s banking supervisor, Pier Carlo Padoan told a newspaper that the ECB’s new capital target was the result of a “very rigid stance” in its assessment of the bank’s risk profile.

 

“It would have been useful, if not kind, to have a bit more information from the ECB about the criteria that led to this assessment,” Padoan told the financial newspaper Il Sole 24 Ore.

You would think that by now Mr.Padoan would know pretty much everything about Monte Paschi and I note that “very rigid stance” is quite different to saying that the ECB is wrong. If we look at the numbers then using the word embarrassing simply does not tell half the story.

Monte dei Paschi, Italy’s third biggest lender and the world’s oldest, said on Monday the ECB had estimated its capital shortfall at 8.8 billion euros (7.5 billion pounds), compared with a 5 billion-euro gap previously indicated by the bank.

So the fake news that was most prevalent about Monte Paschi in 2016 was driven by the Ittalian government and the Bank of Italy telling us that a 5 billion Euro private rescue could work. In fact they would have lost their money just like the previous 3 rescues as it was not enough. In some ways it reminds me of the rights issue of around £12 billion that Royal Bank of Scotland undertook only a few months before collapsing which must have been based on a misrepresentation and should have resulted in prosecutions accordingly.

What no doubt is particularly irking Finance Minister Padoan is this from The Bank of Italy.

The difference between the amount of the capital injection for Banca Monte Dei Paschi di Siena calculated on the basis of the ‘market solution’ (€5 billion) and the amount required in the case of a ‘precautionary recapitalization’ by the Italian state (€8.8 billion) depends on the different hypotheses and objectives of the two measures, which also imply different methods of calculation and lead to different results.

We get a long explanation of the detail in an attempt to divert us from the fact that the Bank of Italy knows the Euro area recapitalisation rules and thus has deliberately overlooked them until now. As we progress we see not only the cost to the Italian state but the sum set aside for compensation to the retail bondholders.

the immediate cost to the State would therefore amount to about €4.6 billion (€2.1 billion to cover the first requirement and €2.5 billion to satisfy the second); to this must be added the subsequent compensation of retail subscribers (about €2 billion, to be verified on the basis of the status of the subscribers and their actual willingness to adhere to the State compensation scheme), for a total of about €6.6 billion.

This morning Italy’s new Prime Minster has joined the fray as shown below from Il Sole 24 Ore.

In his first end-of-year news conference, new Italian Prime Minister Paolo Gentiloni……….This content is now becoming “subject of a discussion with the supervisory board of the ECB, while the tranquillity, size and significance of our intervention is not in question.”

What has he left to discuss? Also given the lifespan of Italian Prime Ministers which is the same as UK Premiership football managers he first end of year news conference may also be his last.

The 20 billion Euro problem

Is this an official denial that “up to” now means more than? From Prime Minister Gentiloni again.

As affirmed by Padoan in recent days, the €20 billion from the bank rescue decree is still enough to help both MPS and other banks, such as the two Veneto lenders (Veneto Banca and Popolare Vicenza), run by the Atlante Fund, which could seek extraordinary public support.

The obvious truth is that like the two efforts at funding the Atlante private-sector bank rescue vehicle it is simply not enough. Some of the smaller sums might have worked if they had been applied early enough and been accompanied by genuine reform but in the meantime things have been allowed to rot and deteriorate.

Meanwhile Monte Paschi is going to issue some more debt according to Reuters. Please form an orderly queue.

Italy’s Banca Monte dei Paschi di Siena, which is being bailed out by the state, plans to issue 15 billion euros ($15.8 billion) of debt next year to restore liquidity and boost investor confidence, several newspapers said on Friday.

Comment

There are not many subjects in the financial sphere that have been subject to fake news more than Monte Paschi over the past few years. The really damning part of this is that so much of that has come from the government of Italy as well as the bank’s board. All the claims of business of usual have been replaced by a need of 8.8 billion Euros of equity capital and 15 billion Euros of bonds. Underlying this is a banking legal system called the “Draghi Laws” after the current president of the ECB after his time at the Italian Treasury and the Bank of Italy. Time for some Fleetwood Mac.

Tell me lies
Tell me sweet little lies
(Tell me lies, tell me, tell me lies)
Oh, no, no you can’t disguise
(You can’t disguise, no you can’t disguise)
Tell me lies
Tell me sweet little lies

Meanwhile Finance Minster Padoan is on the wires again. From Reuters.

“The bank is in optimal condition and will have great success,” he said.

Of Monte Paschi, Mario Draghi and the ECB

Today let us turn our attention to the long-running theme which is the Italian banking sector and in particular Banca Monte dei Paschi di Siena (BMPS) the world’s oldest bank. There was always going to be action post the Italian referendum actually whichever way the vote went but in particular with a no vote. This morning our favourite penny stock has been giving us an example of this as highlighted below by the Financial Times.

Care is needed with the chart as the old Y axis trick is at stake and misses past vastly larger falls in the share price of BMPS. But let us examine the news which has brought us here. Reuters was on the case yesterday afternoon.

The Italian treasury is considering raising its stake in Monte dei Paschi di Siena (MI:BMPS) to help the ailing lender remain in business by buying subordinated debt held by retail investors and converting it into equity, two sources with knowledge of the matter said.

The classic leak to see what the reaction is, trial balloon! Is there an Italian version of Yes Prime Minister? After all such a move would be against Euro area banking rules. It would also be something of an electoral bribe as the retail investors who bought bank debt stock ( what could go wrong?) get the equivalent of the PPI payouts in the UK, although the difference would be that the Italian taxpayer was explicitly paying for it.

On top of that the treasury would buy junior debt held by retail investors to ensure they do not suffer any losses, one of the sources said.

A second source within Italy’s government confirmed the plan. Some 40,000 retail investors hold around 2 billion euros of the Tuscan bank’s junior bonds.

This morning

The written equivalent of rhetoric has gained pace according to La Stampa via Google Translate.

But the only rescue of Siena would be like closing a hole in a tank full of holes. The decree to which the Treasury works worth far more than the three-five billion invoked the market for Siena, and at the moment does not provide for the direct intervention of the state, but that of Europe through the bottom Save-States ESM. The dancing figure indicated by two concordant sources of the Treasury is 15 billion euro.

I did enjoy “like closing a hole in a tank full of holes” as a description of BMPS and wonder what the Italian phrase is for this? Also there is a problem with using the ESM.

The ESM funds are formally a loan and therefore involve the signing of an agreement with Europe which requires those in technical jargon are called “conditionality.”

So what was called the Troika until that came to be debased and is now called the institutions ( a bit like the leaky Windscale nuclear reprocessing plant in the UK became leak-fee Sellafield) would be setting rules for Italy. Although them being applied seems unlikely with La Stampa pointing out that Spain applied them in theory rather than in practice. The other main issue is that Euro area banking rules have changed and now require bail-ins rather than bailouts although of course even the “rules-based organisation” the ECB has bypassed a few rules in its time.

How did we get here?

The meeting on Monday for the 5 billion Euro debt for equity swap does not seem to have got anyone to put their hands in their wallets or purses. I can’t say I blame them.

The time line of a banking bailout

I have posted this several times before but it seems appropriate to give it another airing.

1. The Board issues a statement accusing bloggers of spreading both irresponsible and factually incorrect rumours as the bank is sound and has no need of new capital.

2. The Bank issues a statement of confidence in its management.

3. The Bank tries to raise more private capital in spite of it having no need for it.

4. If this does not work the relevant government(s) express(es) complete confidence in the bank and tell us that it has a sound management structure and business model. Indeed the bank had only recently been giving the government advice as to how to run the public-sector more efficiently.

5. The relevant government(s) tell us that they are stepping in to help the bank but the problems are both minor and short-term and are of no public concern.

6. The relevant government(s) tell us that the bank needs taxpayer support but through clever use of special purpose vehicles there will be no cost and indeed a profit is virtually certain.

7.Part-nationalisation of the bank is announced and taxpayers are told that a profit will result from this sound and wise investment.

8. Full nationalisation is announced to the sound of teeth being pulled without any anaesthetic.

9. Debt costs of the relevant sovereign nation or nations rise.

10. Consequently that nation finds that its credit rating is downgraded.

11. It is announced that due to difficult financial times public spending needs to be trimmed and taxes such as Value Added Tax need to be raised. It is also announced that nobody could possibly have forseen this and that nobody is to blame apart from some irresponsible rumour mongers who are the equivalent of terrorists. A new law is mooted to help stop such financial terrorism from ever happening again.

12. Some members of the press inform us that bank directors were both “able and skilled” and that none of the blame can possibly be put down to them as they get a new highly paid job elsewhere.

13. Former bank directors often leave the new job due to “unforseen difficulties”.

We seem to find ourselves at point 7 although I must warn you that point 8 can then arrive faster than Usain Bolt.

Enter Mario Draghi

The President of the European Central Bank has been involved in this issue for years and indeed decades as I pointed out on the 21st of January.

If we look further back in time we see that the law covering Italian financial markets is often called the Draghi Law and we note that around the turn of the century he was Director General of the Italian Treasury. Then he went to Goldman Sachs which was busy designing derivatives for Italy and Monte Paschi as well as Greece before returning to head the Bank of Italy. So if there is a crime his fingerprints are all over it.

Of course Mario issued his “everything it takes” speech in the summer of 2012 which was explicitly for the Euro but also has implicitly helped the Italian banks. For example the sovereign bond buying of its QE program has given profits to their large holdings of Italian government debt. The purchases of mortgage debt must have helped their mortgage books as well. Yet in spite of this we are where we are.

Actually he went further before the referendum when he promised to step-up purchases of Italian government bonds should the vote be no. So my argument against Italy going to the ESM would be that it could issue the debt itself very cheaply with Mario’s bond buyers hovering in the background and maybe foreground. Awkward though if his bond buying allows Italy to break the new ECB driven bank bail in rules. After all he keeps telling us that the ECB is a “rules based organisation”.

I expect him to announce tomorrow that the ECB programs will not end in March and give us something along the lines of  a 6 month extension. His committees well report but have lost a lot of their modus operandi with the post Trump rise in bond yields although there is still the “safe haven” issue of Germany’s 2 year debt being issued today at -0.71%.

Comment

This has been a very long-running saga but one of my markers is back in play.

Italy is not preparing a request for a loan from the European Stability Mechanism (ESM) to support its banking sector, a Treasury spokesman said on Wednesday, denying a newspaper report.

Never believe anything until it is officially denied!

Of course the media produce all sorts of stories as we see in the world of football transfers where all sorts of inflated numbers appear as click bait. But some of them like Paul Pogba to Manchester United do happen. This is where we find ourselves as for example saying this makes Italy insolvent is not quite true. The QE dam of Mario Draghi holds back that flood for now and maybe “To Infinity! And Beyond” so point 9 of my banking timeline may be skipped. However without QE Italy would face solvency questions which a bank bailout would merely add to.

I bet they now wish they had like used the ESM in 2012 like Spain did.

Number Crunching

For BMPS from here on the 21st of January.

MontePaschi: Total capital raised since 2008: €14bn Market value today: €1.5bn ( h/t Macrocredit )

For Italy from Istat earlier.

The unemployment rate remained stable for the fourth consecutive quarter in comparison to the previous quarter and up 0.4 points from the same quarter of 2015, with a growth rate of 132 thousand unemployed.

Not much sign of any recovery there…

Time for The Italian Job?

In a year of events which were seemingly considered unexpected and at times unthinkable by the establishment we now face another role of the dice. This comes over the weekend in Italy. There is an irony that on the face of it the issues are domestic ones. As the Guardian describes below.

A series of major changes to the Italian political system. These reforms, which affect a third of the Italian constitution, have already been approved by parliament but by a slim margin, thus requiring that they also be passed by referendum……Under the proposed reforms, the Senate would lose almost all its power – the number of senators would be reduced from 315 to 100, and the remaining senators would no longer be elected directly.

The idea is to speed up legislation by in essence going from 2 political chambers to one to stop this sort of thing happening.

his means, put simply, that it can take a very long time for things to get done. For example, a law to give children born out-of-wedlock the same rights as children of married couples took nearly 1,300 days to be approved.

How very Italian! Which is of course part of Italy’s charm and also part of the problem. Another sign of this being Italy is that apparent reform involves creating an unelected second chamber. But the fundamental issue is that as so often happens the question on the ballot paper has morphed into becoming something of a vote on Prime Minister Renzi himself. Not perhaps the best plan when anti-establishment forces seem to have the upper hand. But as ever I will leave the political debate alone.

The economics

I recall that the appointment of Prime Minister Renzi was claimed as a new dawn for Italy and that his reforms would lead to much better economic growth. I remember asking supporters what changes were about to happen? If we look at yesterday’s update some 2 and a bit years down the road there seems to be little sign of progress.

In the third quarter of 2016 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.3 per cent with respect to the second quarter of 2016 and by 1.0 per cent in comparison with the third quarter of 2015.

The progress that there has been sees annual economic growth at 1% as opposed to 0.3%. So higher but of course feeds right into my theme that Italy struggles to get its economic growth rate above 1% in the good times. Are these good times? Well ECB President Mario Draghi keeps telling us that it is the negative interest-rates and QE bond buying of the ECB which has pushed economic growth higher. Also this has been a phase of a lower price for crude oil and indeed other commodities which should also have boosted the Italian economy. As per yesterday’s article that may be fading but as we look back it has certainly been in play.

Actually Mario Draghi may have been thinking of his home country when he said this in Wednesday.

Without concerted effort on structural reforms, per capita income growth in euro area is likely to stagnate or even decline

Per capita GDP has fallen by around 6% since it joined the Euro by my calculations. Whereas he is pointing out he things others have made ch-ch-changes.

Reforms in Spain in mid-2012 are example of a structural reform that has been successful in unblocking the labour market.

What country was he thinking of as a comparison with Spain here as he is interviwed by El Pais?

It is also true that Spain enacted reforms and repaired its financial sector earlier than others, which has proved crucial.

Every ECB meeting there is a part of Mario Draghi’s speech which is as nailed on as say Sergio Parisse in the Italian rugby team. It calls for structural reforms and is an example of rinse and repeat.

The banks

Last weekend the Financial Times shifted towards panic mode.

Up to eight of Italy’s troubled banks risk failing if prime minister Matteo Renzi loses a constitutional referendum next weekend and ensuing market turbulence deters investors from recapitalising them, officials and senior bankers say.

I guess you are wondering which 8?

Italy has eight banks known to be in various stages of distress: its third largest by assets, Monte dei Paschi di Siena, mid-sized banks Popolare di Vicenza, Veneto Banca and Carige, and four small banks rescued last year: Banca Etruria, CariChieti, Banca delle Marche, and CariFerrara.

Not Unicredit? That would make nine like say the Nazgul.

Monte Paschi

Let us stick with the world’s oldest bank for as moment and there is maybe a saviour on the horizon. From @creditmacro.

MontePaschi may sign preliminary investment agreement with Qatar Investment Authority between Saturday and Monday, Il Sole 24 Ore reports.

Mind you to that ying there is also a yang as Reuters have just reported.

Italy is discussing with the European Commission the terms of a state bailout of ailing bank Monte dei Paschi (BMPS.MI) that has already been requested and could be launched next week if needed, Italian daily Corriere della Sera reported on Friday.

Italy’s third-largest bank needs to raise 5 billion euros ($5.3 billion) by the end of the year to plug a capital shortfall identified by European Central Bank stress tests or face the risk of being wound down.

Care is needed as we have “may” on one side and “could be” on the other. But we do at least have an official denial and we know what they mean! From @livesquawk.

Italian Govt Undersecretary: MontePaschi Will Not Need State Help – ANSA

Anyway the Bank of Italy is dreaming of the future as it let is know on Wednesday.

The Bank of Italy has identified the UniCredit, Intesa Sanpaolo and Monte dei Paschi di Siena banking groups as other systemically important institutions (O-SIIs) authorized to operate in Italy in 2017. The three groups will have to maintain a capital buffer for the O-SIIs of 1.00, 0.75 and 0.25 per cent respectively of their total risk exposure, to be achieved within four years according to the transitional period shown in Table 1.

So SII has replaced SIGI which replaced TBTF ( Too Big To fail) as we go acronym crazy. Do I have that right?

Oh and if you are systemically important should they not all have the same thresholds?

Comment

We find ourselves facing for the first time in 2016 an event where this time the “shock” result is the expected one. Accordingly financial markets should have made much of their adjustment already. Although on the face of it I find it is hard to see much insurance in an Italian two-year government bond yielding 0.22% or indeed a five-year one yielding 0.89%. But perhaps as Reuters reports Mario Draghi has a put option ready for them.

The European Central Bank is ready to temporarily step up purchases of Italian government bonds if the result of a crucial referendum on Sunday sharply drives up borrowing costs for the euro zone’s largest debtor, central bank sources told Reuters.

Ah that word “temporarily” again! Those most annoyed by this should be the Portuguese who have much higher bond yields but by contrast have seen fewer bond purchases than their theoretical share.

As for the Euro it has drifted lower recently as we note an exchange-rate around 1.06 to the US Dollar and the UK Pound has regained ground to 1.18. The trade-weighted move has been from 96.1 to 94.4 so relatively minor. However looking forwards whilst there could be a knee-jerk fall surely an increase in the possibility of Italy leaving the Euro makes it more of a “hard” and “safe-haven” currency so it could later rise.

Don’t get a job involving numbers

This is from a Bank of Italy working paper on undeclared assets.

Third, it estimates the portion of tax evasion connected to the underreporting of foreign assets to range between $20 trillion and $42 billion a year over the period 2001-2013 for capital income tax,

Thanks for that!