Can Mario Draghi and the ECB help Italy?

Yesterday was quite an extraordinary day especially in Italian markets. However I wish to move on to consider things from the new tower of the European Central Bank. So as we move geographically to the Grossmarkthalle in Frankfurt we would have seen concern and probably not a little panic. The phone lines would have been burning between Frankfurt and the Bank of Italy as they discussed how to respond. At first this would have been on a tactical level about the ongoing QE ( Quantitative Easing) bond buying programme but of course the higher echelons and strategy would pretty quickly have been in play. However you spin it the billion Euros or so a week of buying of Italian bonds might have lasted all of thirty minutes if that if it was spent all in one go! I do not know if the weather was the same as in London but the storms were appropriate.

There was no formal Governing Council Meeting but I am sure that President Draghi and the Executive Board would have been in contact and others would have taken an interest. Some may have had a wry smile as up to this week the main issue would have been the location of the meeting next month in Riga Latvia. There the issues would be corruption, money-laundering and in some respects the ECB trying to put itself outside the legal system. Now the question on everyone’s minds would be Italy and the political crisis triggered there and in particular the impact on debt markets

What could the ECB do?

The obvious first move concerns the QE bond buying. This is something of a new situation as it is the first case of a major bond market facing a price rout with both flow QE as in ongoing purchases and a stock of it as the ECB has bought around 342 billion Euros of Italian government bonds so far. Thus the latter would not be sold and it would have been bought mostly from those who might have done in the situation unfolding. Yet it was not enough and the ECB has tied its own hands.

What I mean by this is that in order to get its 19 constituent nations to agree to the QE plan it buys according to their Capital Key. This is the effective shareholding of each country and reflects factors such as their relative GDP and Italy is approximately 17.5% so that is what it gets. There is scope to vary this but not a lot as Mario Draghi explained in January.

 The ECB doesn’t favour certain countries over others in its PSPP purchase programme implementation. As you know, purchases are guided by the ECB’s capital key, which takes into account GDP and population. Now, focusing excessively on any particular purchase period, for example on 2017 only, could result and yield wrong interpretations. The overall stock of Eurosystem PSPP holdings is the relevant metric for any assessment of the programme and not the recent purchase flows.

Back then too much German debt was held and too little Portuguese.

These flows can differ as the design of the programme is flexible and the distribution of actual purchases often deviates from the ECB capital key.

So whilst there is flexibility there is nowhere near enough especially as the numbers would be released next Monday and everyone would see. Actually I think the flexibility was used up last Wednesday when the ECB in baseball terms stepped up to the plate and then withdrew. No doubt there were discussions about modifying the programme but I doubt they got far and the word nein would not have been needed.

Some have been suggesting the ECB could buy more but at the moment that is a non-starter. Of course we have seen such things change but persuading German and other taxpayers to potentially bankroll a new coalition government in Italy hoping to “spend spend spend” will not be easy.

Securities Markets Programme

This was used in the Euro area crisis.

About e220 billion (bn) of bonds (par
value, excluding redemptions) were acquired from 2010 to early 2012. Greece, Ireland, Portugal, Spain, and
Italy.

As described it does seem to fit the bill.

First, purchases within the SMP occurred during a severe sovereign debt crisis, when sovereign yields in several euro area countries were high, rising, and volatile.

Of course you could argue that in spite of yesterday’s surge in Italian bond yields with the ten-year around 3% as I type this that is not high compared to the 7% of the Euro area crisis. Also the programme is shown as terminated on the ECB website although 84 billion Euros of bonds are still held.

However it is worth noting because the replacement called OMTs or Outright Monetary Transactions have never been used.

Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above.

That is an issue because Italy is not in one and you could hardly see Mr. Sissors persuading the Italian parliament of much at all right now let alone this. That is unfortunate from the point of view of the ECB because like the SMP it operates like this.

Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.

This matters because there have been some extraordinary events in short dated Italain government bonds. As recently as the fifteenth of this month the two-year yield was negative reflecting the easy ECB monetary policy and the -0.4% Deposit Rate. Yesterday it rose as high as 2.8% and today it is 2%. So some extraordinary moves with t hose who bought a fortnight ago feeling rather silly I guess.

Wider Moves

The issue here for the ECB is that not only has it been tapering its QE programme but it has been hinting at its end. That makes it awkward to fire it back up. Of course should the current weaker patch for the economy persist then it might provide an excuse/reason but it is just as true that the effect on inflation from the higher oil price is pushing in the opposite direction.

Comment

The ECB finds itself between a rock and a hard place in two respects. The first is that additional bond purchases might turn out to be an own goal if the likely governing coalition returns to its proposal involving the ECB writing off 250 billion Euros of it.Next comes the issue of Greece which does not qualify for QE in spite of enormous efforts and it might reasonably ask how a fiscally expansionary government in Italy qualifies?

There could be specific efforts to help the Italian banks although of course they have received an extraordinary amount of help as it is! Most still seem to be troubled and burdened with bad and sour loans. Mario Draghi was always very keen on buying Asset Backed Securities which I always thought was a way of helping the Italian banks in particular but as we look we see a barrier.

At the time of inclusion in the securitisation, a loan should not be in dispute, default, or unlikely to pay. The borrower associated with the loan should not be deemed credit-impaired (as defined in IAS 36).

Here is my suggestion for the ECB loudspeakers from The Sweet.

Does anyone know the way, did we hear someone say
(We just haven’t got a clue what to do)
Does anyone know the way, there’s got to be a way
To blockbuster

 

Meanwhile the Euro has recovered a bit today and is above 1.16 versus the US Dollar.

 

 

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The Italian bond and bank crisis of May 2018

Oh what a difference a couple of days can make, especially in Italy right now. However we can see the cause of this quite easily and have done so more than a few times in the past. Back at the end of the last century when the Euro currency concept was being prepared its supporters argued that it would bring economic convergence to its member countries. The reality for Italy has been this if we look for an individual measure of economic performance.

The convergence issue has been a disaster for Italy. Ironically it seemed to be holding station with Germany before the Euro began but since it the German locomotive has powered ahead leaving the Italian carriage in a siding. If you had set out to diverge the two economies it would have been hard to do better ( worse?) than this. Also my theme that Italy struggles in the relatively good times was at play in the early part of the century. Then it was hit hard by the credit crunch and the Euro area crisis and sadly has still not fully sorted its banking problems.

Poverty

Another way of observing the Italian economic experience has been provided in a paper from the Universities of Modena and Rome which point out another reversal.

The paper explores the changing risk of poverty for older and younger generations of Italians throughout the republican period, 1948 to the present day. We show that
poverty rates have decreased steadily for all age groups, but that youth has been left behind. The risk of poverty for children aged 0-17, relative to adults over 65, has
increased steadily over time: in 1977, children faced a risk of poverty 30 percent lower than the elderly, but by 2016 they are 5 times likelier to be poor than someone in the age
range of their grandparents.

It is easy to always look at the bad side so let us take a moment of cheer as we note that in general poverty has fallen since the second world war and mankind has stepped forwards. However the rub as Shakespeare would put it is that the times may be a-changing and the poverty we see now in Italy is concentrated in younger age groups. This reminds me of another statistic.

Youth unemployment rate (aged 15-24) was 31.7%, -0.9 percentage points over the previous month.

So as the overall unemployment rate is 11% then the youth unemployment rate must be treble that of older age groups. Which means that they have gone back to the future.

As a matter of fact, young Italians today face approximately the same risk of poverty as their equals in age in the 1970s. No economic miracle has happened for them, and none is expected.

This seems to have been a deliberate policy as we note this.

 Our analysis points to the welfare state, which offers better protection for the elderly than it does for
the young and their families………More importantly, the
elderly continued their march towards a poverty-free existence, while the youth did not.

This leads to a rather chilling statement.

Overall, in the last seven decades, Italy has become no country for young people.

Some of this is an international issue as for example the UK had the triple-lock for the basic state pension but some is specifically Italy.

National Debt

This is an issue but not in the ordinary way. This is because what can be described as the third biggest national debt in the world has not be caused by fiscal recklessness. In recent times Italy has been restrained. The problem has been the one described above which is the lack of economic growth. On such a road to nowhere even small fiscal deficits see the national debt rise in relation to economic output or GDP (Gross Domestic Product).

Perhaps the new Prime Minister will live up to his “Mr. Scissors” nickname in this area but it will be hard for a man facing a confidence vote to do much I would think.

Italian bonds

As you can imagine this has felt just like old times for me and in spite of yesterday being a glorious bank holiday at least until the evening thunderstorm I was transfixed for a while by what was happening. Two old rules of mine worked as well.

I like the idea of applying something I was taught at the LSE albeit with a personal spin as so much has found its way into the recycling bin. Nobody seems to pick it up either which means it is set fair for the future. The other is that you buy an intraday fall of more than two points. That worked as well but with the caveat that it was a case of the “quick and the dead” and you would have been stopped out today.

Moving to the state of play as I type this we see what has become a bloodbath. The Italian BTP bond future has fallen 5 points to a low of 124 and this compares to a bit over 139 as recently as the 7th of this month. Putting it another way the ten-year yield has risen from 1.76% to 3.1%. This may not seem large moves so let me explain the issue in the QE ( Quantitative Easing) era.

  1. They are bigger than you think and an example of this is the way the US Treasury Bond market used to have a trading halt after two point moves. Annoying at the time but does give a breather.
  2. In the QE era there is the view that the central bank will bail things out and that to quote Flo “the dogs days are over”
  3. This may have tempted investors to increase position size to make a profit which of course would now be in trouble.
  4. As implied volatilities fall it is tempting not only to put on derivative positions but to increase their size as human nature is particularly vulnerable at such times.

We have two clear examples of such events. One I traded through which was the LTCM crisis of the late 90s which was a case of intellectual arrogance and of course we had the travails of the VIX index earlier this year.

Whatever It Takes

The famous saying from ECB President Draghi from the summer of 2012 of course had to save the Euro as an implication but some translated it as “to save the Italian banks”. We have followed over time the multitude of issues here but as we looked at last week another problem emerged on Thursday. From @YanniKouts.

The minute the markets will realize that Italy will restructure its debt, the Italian banks and eventually the economy will collapse. Corralito.

Since then the share prices of the Italian banks have moved into yet another bear market. Our old friend Monte Paschi the world’s oldest bank is at 2.32 Euros down 5% today or 1 Euro lower than a fortnight ago. Those of a nervous disposition might like to look away now as I point out that compares to a pre credit crunch peak of more like 7700 Euros. In a way the Italian financial crisis can be summed up by Prime Minister Renzi saying it was a good investment. Oh and as Polemic Paine reminds us a past theme is in play right now.

Waiting for second round effects from all the private hands that clamoured to buy the Italian banks’ dodgy debt.

These days the role of the ECB has increased as of course it is also the banking supervisor which I think is a bit like being Liverpool’s goalkeeping coach.

Comment

There is much to consider here and let me throw in something from this morning’s data which will not help. From the ECB.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation
and overnight deposits, decreased to 7.0% in April, from 7.5% in March.

Another hint of an economic slow down albeit broad money was a little better. Moving to the financial crisis this will be felt by individual Italians as they are savers and for example around 64% of Italian debt is held by domestic hands. So they are losing and whilst overseas investors are in a minority that is still some 685 billion Euros due to the size of the market. Thanks to the Bruegel group for the data. This is of course before we get to the stock market and those holding bank debt. Remember when we were told what great deals the bank debt was? Also the “protecting savers” part from President Mattarella not only goes into my financial lexicon for these times but will be part of what historians will call the Mattarella Error.

As a final though this has answered a question we have been asking for a while. What would get the Euro to fall? This has been answered as we note it has dropped to 1.15 and a bit versus the US Dollar and even the UK Pound £ has nudged a little higher to the nearly the same number.

 

 

 

An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

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.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.

Comment

This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?

Euro area monetary policy heads for a new frontier

The issue of monetary policy in the Euro area is of significance on several levels. Obviously it affects the Euro area itself but also it affects many countries around it as in a nod to the sad departure of Stephen Hawking overnight it is time to sing along with Muse.

Into the supermassive
Supermassive black hole
Supermassive black hole
Supermassive black hole
Supermassive black hole

This has been demonstrated by the way that zero and then negative interest-rates ( a deposit rate of -0.4%) in the Euro has forced others in the locale to follow suit. It was and is a factor in the -0.5% of Sweden the -0.65% certificate of deposit rate in Denmark and the -0.75% of Switzerland amongst others. It is also a factor in the UK still remaining with a Bank Rate of 0.5% after so many years have passed and not following the more traditional route of aping the moves of the US Federal Reserve.

What next?

This is the question on many lips both inside for obvious reasons but also outside the Euro area for the reasons above. Why? Well the President of the European Central Bank Mario Draghi explained this earlier today in Frankfurt.

The economy has been growing consistently above current estimates of potential growth, by more than a percentage point last year. All euro area confidence indicators are close to their highest levels since the start of monetary union, even if the latest readings came in slightly below expectations.

This as I regularly point out means that monetary policy is facing a new frontier. This is because it is procyclical where it is expansionary in an existing expansion. Mario has in fact gone further than me in one area as in his view it is even more procyclical leading to output being more than 1% above potential. If that sounds a little mad I will return to it in a moment.  But another factor in this new frontier is the way that both negative interest-rates and QE have been deployed.

We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier ( Donald Fagen)

Potential Output?

Looking at what output has been allows us to figure it out.

Over the whole year 2017, GDP rose by 2.3% in the euro area ( Eurostat)

That would mean that potential output is only 1% per annum but I suspect Mario really means the 2.7% if you compare the last quarter of 2017 with a year before so 1.5%. That is rather downbeat which is very common amongst central bankers these days as for example Governor Carney and the Bank of England used different language “speed limit” for the UK but also came to 1.5%. Due to demographic pressures the Bank of Japan is even more downbeat for Nihon at 1%.

We will see how the media treat that as they make a big deal of the UK situation but let is move onto what causes them to think this? We come to something which is genuinely troubling.

Second, the degree of slack itself is uncertain. Even if slack is now receding, estimates of the size of the output gap have to be made with caution. Strong growth may be leading to higher potential output, as crisis-induced hysteresis may be reversed in conditions of stronger demand. And the effects of past structural reforms, especially in the labour market, may now be showing up in potential output.

As you can see the certainty of earlier has gone as this clearly points out they do not know. We are back to imposing theory on reality again and even worse a failed theory as later we get this.

Phillips curve decompositions find that past low inflation dragged down wage growth from its long-term average by around 0.2 percentage points each year between 2014 and 2017.

If we step back we see that according to the Phillips Curve wages should be soaring as we are above potential output whereas in fact they are doing this.

 The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

As in there is no link visible yet but if you inhale enough hopium it will be along at some point! Also I hope you enjoyed the reference to labour market reforms from Mario as we mull the contrast between that and his policy press conferences which every time without fail have a section calling for economic reform.

More! More! More!

It is somewhat awkward when you are telling people the economy is running hot and implying it is overheating if you also say it may be about to run faster.

Non-essential purchases – which make up around 50% of household spending in the euro area – tend to be postponed during recessions and then to catch up as the business cycle advances. Such purchases are currently only 2% above their pre-crisis level, compared with 9% for essential ones. This implies that discretionary household spending still has scope to support the expansion.

So it is below potential Mario? Also an area central bankers love to see boom also seems to be below potential.

Moreover, housing investment is still 17% below its pre-crisis level and is only now starting to pick up, which will likely add an extra impulse to the recovery dynamic.

What about inflation?

This if you look at a Phillips Curve world should be on the march in both senses as wages and prices should be heading upwards and yet.

Wage growth has been trending upwards for the euro area as a whole, rising by 0.5 percentage points from the trough in mid-2016.

Not much is it? As to be fair Mario points out.

But consistent with the weakening of the relationship between slack and inflation, the adjustment of wages during the recovery has so far been atypically slow.

The trouble is the analysis seems to be based on pure hopium.

That said, our analysis suggests that, as the cycle advances, the standard wage Phillips curve should hold better for the euro area on average. The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

So when you really want it to work ( in a crisis) it fails and in calmer times it does not seem to work either. But they will continue with it anyway like someone who s stuck in the mud.

Comment

Actually I think that Mario Draghi is more intelligent than this as we see several themes come together. Back in the dim and distant days when I began Notayesmanseconomics I offered the opinion that central bankers would dither when it became time to reverse course on their stimuli. This became a bigger factor as the stimuli grew. Now we see a central banker telling us.

But we still need to see further evidence that inflation dynamics are moving in the right direction. So monetary policy will remain patient, persistent and prudent.

This works nicely for Mario as the inflation forecasts remain below the 1.97% inflation target defined by a predecessor of his ( Monsieur JC Trichet).

The latest ECB projections foresee a pickup in headline inflation from an average rate of 1.4% this year to 1.7% in 2020.

Thus as he has hinted at in past speeches which more than a few seem to have forgotten Mario Draghi may depart as ECB President without ever raising interest-rates. In fact it seems to be his plan and it is something he will leave as a “present” for whoever follows him. Another form of stimulus may have slowed but is still around as well.

The cumulative redemptions under the asset purchase programme between March 2018 and February 2019 are expected to be around EUR 167 billion. And reinvestment amounts will remain sizeable thereafter.

So now we see that policy has been decided and a theory ( Phillips Curve ) has been chosen which is convenient. Mario may not believe it either but it suits his purpose as does claiming their has been labour market reform. This is the same way that we have switched from the economic growth of the “Whatever it takes” speech to inflation now both suggest the same policy which allows Mario to give himself a round of applause.

 Considering all of the monetary measures taken between mid-2014 and October 2017, the overall impact on euro area growth and inflation is estimated, in both cases, to be around 1.9 percentage points cumulatively for the period between 2016 and 2019.

So another masterly performance from Mario Draghi but it should not cover up the many risks from advancing onto a new frontier of procyclical monetary policy.

 

 

 

 

The problem that Steinhoff poses for both QE and the ECB

Yesterday ECB President Mario Draghi was in bullish mood and in some ways why not as the economy of the Euro area has had a good 2017. He was also able to spread some Christmas cheer by raising the economic growth forecasts.

Draghi: GDP projections: 2.4% in 2017 [2.2% in Sept], 2.3% in 2018 [1.8%], 1.9 in 2019 [1.7%] and 1.7% in 2020

However there was an issue which gave a sour note to proceedings and it came from a topic I looked at on the 7th of this month which is the saga of Steinhoff holdings.

The initial response was one of deflection.

Your second point about the bonds, well, first of all let me say that this programme is one of our policy tools that we consider important – very important – for the attainment of our mandate.

Sadly this remained unchallenged because if you reduce corporate bond yields there is a long and winding road at best to you achieving an inflation target of 2% per annum. This from the ECB August Economic Bulletin is derisory in some respects.

 In pursuing its objective of maintaining price stability, the ECB is mandated to act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources.

How is favouring larger companies by allowing them to fund more cheaply and perhaps for bigger amounts “free competition”? Smaller companies would not consider it to be like that. If you look at the data the issue of an “open market economy” is called into question as well.

CSPP holdings stood at €92 billion as at 7 June 2017, corresponding to around 11% of the CSPP-eligible bond universe.

As the holdings are now 130.2 billion Euros then presumably it owns over 15% now. At what point are markets not open? Also and something that is relevant to the current problem is that the biggest gainers have been companies who are at the riskiest end of the investment grade spectrum. If we allow for an anticipation effect then five-year yields for BBB- companies have fallen from over 3% to more like 1%.  Thus a side -effect is that nearly all the “yield for risk” if I may put it like that has been removed from the “open market” here. Here is a crux of the matter which is that the ECB is subsidising such companies which opens quite a few dangers.

If we return to Mario Draghi we were told this.

 The scope of the programme is not to maximise profits or to avoid losses, so let’s keep this in mind. Having said that, running such big corporate programmes, it’s not unusual that losses may be happening.

Indeed it is going well.

Certainly we have a risk framework which has served us very, very well since the beginning of the existence of the ECB.

Or maybe not.

Certainly if we need to draw lessons we’ll do – we’ll certainly draw lessons from this experience. We are always open to improve, but as I said it’s been very, very good. Also as soon as we got news, we stopped buying.

I should think they did stop buying! “As soon as we got news” is quite a confession if you think about it. Also institutions regularly claim to draw lessons whereas in fact it is a type of kicking it into the long grass tactic as the media hounds move on and the perceived crisis passes.

Next in the deflection playbook is to rubbish existing reports.

Also let me add that the losses that had been reported are by and large exaggerated by a factor of 10 with respect to the actual measure of the losses.

You may note that no actual figure was mentioned in spite of this claim.

 we are different because we are much, much more transparent about our programme.

Anyway the losses are really not very important.

But having said that, having said all this, the losses are there. They are not realised and so the issue is, who’s going to pay for these losses? The answer is that these losses really represent a small digit factor number of our €1.6 billion net interest income we produced last year.

Number Crunching

It looks as though someone has leaked something as the Financial Times is reporting this.

The ECB this year bought parts of a €800m bond issued by Steinhoff and is thought to hold about €130m. The bond is due to mature in early 2025 and has a coupon of 1.875 per cent. The bond was acquired by Finland’s central bank as part of the ECB’s bond-buying programme.

So no Chianti special reserve for the Governor of the Bank of Finland at the ECB Governing Council Christmas party just tap water.

Let me correct a mistake I have made which is that losses and profits in this programme are fully shared by the national central banks as it is part of the 20% below.

The ECB is committed to the principle of risk-sharing, and that’s why 20% of the purchases fall under the regime of full risk-sharing.

Steinhoff

The news here goes from bad to worse.  From the FT.

Steinhoff on Wednesday night announced that the accounting irregularities are not only confined to the most recent fiscal year, which ended on September 30, but reached back into the previous one. “The 2016 consolidated financial statements will need to be restated and can no longer be relied upon,” the company said. On Thursday, Mr Wiese tendered his resignation from the board.

As I type this the share price is 8.4 Rand in Johannesburg a far cry from the 45.65 Rand on the 5th of December and nearly 6% lower today alone.

Ratings Agencies

Who could possibly have expected this?

Bankers said that they were caught off-guard because Steinhoff had enjoyed an investment grade rating from Moody’s. ( FT)

The lesson of the credit crunch era that ratings agencies were if not obsolete holed below the waterline seems to have bypassed not only the ECB but the banks.

Wall Street banks including Bank of America and Citigroup are facing potential losses of more than €1bn on loans made to the billionaire backer of Steinhoff International, the South Africa-based home retailer whose shares collapsed last week after disclosing accounting irregularities.  The banks lent €1.6bn to then Steinhoff chairman Christo Wiese in September 2016, which was secured against €3.2bn worth of Mr Wiese’s shares in the company, according to public documents issued by Steinhoff.

As you can see the highly paid banking analysts have been wrong-footed again, will they bear the sort of responsibility those lower in the pecking order would face? It seems unlikely as after all with a central bank having made a mistake too they may step away from the area. Also banks will make mistakes with their lending but the stand out issue here has been summarised well by a reply to the FT.

Another “wizzkid shop owner” has put all their money in his wife’s name in a unfathomable legal system of a third world country.

There was another warning which is  that my late father regularly used to warn me that whilst some companies genuinely go on buying sprees others do so to cover up existing problems.

Comment

There is a lot to consider here as we mull the official ECB line.

Since the financial crisis of 2008, the ECB has adopted a number of unconventional policies that prompted critics to warn that it was about to incur huge losses. The fact is that, ever since its inception, the ECB has continued to make profits

The problem with that is the fact that it has in general been able to enforce this. For example Greece was forced to repay its bonds at par (100) when some form of default would have been far better for it. So the ECB made profits but Greece got more debt. This got so bad that the ECB in fact returned “profits” to Greece. In terms of other purchases it is still buying so newer buys make sure older buys make paper profits. When it comes to sell these bonds there may be a different story.

A four-stage process may apply.

  1. There is nothing to worry about we are making profits.
  2. Something may be happening and we will look into it and learn the lessons..
  3. Maybe we should do something but that is both difficult and dangerous to financial stability.
  4. Perhaps we should have done something but it’s too late now.

Meanwhile there is the issue of subsidising what may be zombie companies and worse. Also markets become ever more controlled and there is a clear bias away from  smaller companies to larger ones ossifying the economic system.

This issue will pop up with other central banks as for example the equity holdings of the Bank of Japan look good partly because it keeps buying. We will learn more when it stops. Also the Bank of England holds bonds on the troubled Maersk which may yet hit trouble although its new “improved” website may hide this.

Update 12.20 pm

Sometimes you really couldn’t make it up.

 

The Italian banks and how they have contributed to a possible end to deposit protection

A regular feature of recent years has been the Italian banking saga where we are continually reassured that banks are fine and then it turns out that they are not. Many of the misrepresentations have come from Finance Minister Padoan who was in fine form in January according to Politico.

Italian Finance Minister Pier Carlo Padoan has defended the way his country dealt with its banking crisis, saying the government had “only spent €3 billion” on bailouts, in an interview with Die Welt published today.

“We are the EU country that has paid the least to save its banks,” Padoan said. Out of 600 banks, only eight “have problems,” he noted, saying the “system as a whole is not in crisis,” having “withstood the financial crisis.”

Apparently this is a mere bagatelle or the Italian equivalent.

Italy’s banking system is groaning under €360 billion in bad loans,

Such is his loose association with the truth he claimed this.

“I assure you, we have no interest in state intervention,” Padoan said

whilst doing this.

The government has set aside a €20-billion fund to save banks, and is expected to provide roughly €6.7 billion of that to prop up ailing Tuscan lender Monte dei Paschi di Siena.

Oh and he had one last go at what in modern parlance is called “misspeaking”.

Everything has been done “according to European guidelines,” the finance minister added, defending the use of bail-ins, whereby creditors and depositors take a loss on their holdings to help rescue a failing bank.

Actually what was about to come drove a Challenger tank through the rules and in my opinion has contributed to potentially ominous developments for bank depositors in the Euro area. At the moment deposits up to 100,000 Euros are covered unequivocally but on the 8th of this month the European Central Bank published an opinion piece including this and the emphasis is mine.

The general exception for covered deposits and claims
under investor compensation schemes should be replaced by limited discretionary exemptions to
be granted by the competent authority in order to retain a degree of flexibility. Under that approach,
the competent authority could, for example, allow depositors to withdraw a limited amount of
deposits on a daily basis consistent with the level of protection established under the Deposit
Guarantee Schemes Directive (DGSD)34,

That has echoes of the demonetisation shambles that took place in India a year or so ago with queues around the corner for the banks. Now let us take care as the deposit protection scheme still exists as I have seen plenty of places on social media claiming it does not but there are questions about it in the future as you can see. One of my themes is in play here as we note that the ECB is much more concerned about “the precious” than the rights and maybe losses of depositors.

The ECB cautions that prolonged periods during which depositors have no access to their deposits undermine confidence in the banking system and might ultimately create risks to financial stability.

You don’t say!

Monte Paschi

Top of the list as ever is the world’s oldest bank and in terms of the terminator it’s back. From Reuters on the 25th of October.

Shares in the bank opened on Wednesday at 4.10 euros, which became the reference price for the session, and then rose to as much as 5.26 euros, up 28 percent.

That price translates to a paper loss of 1.3 billion euros for Italian taxpayers, who are set to hold 68 percent of the Tuscan bank, which was central to public and private finances in Siena and the surrounding region.

Italy’s government paid 6.49 euros a share in August, when it pumped 3.85 billion euros into Monte dei Paschi, and is spending another 1.5 billion euros to shield some of the bank’s junior bondholders, whose debt was converted into equity.

Actually since then shareholders have had a rather familiar sinking feeling as the price as I type this is 3.95 Euros as I type this. Perhaps the former Prime Minister has suggested the shares are a good buy again as of course last time in an unfortunate mistranslation that actually meant good-bye. As I pointed out last week troubles are brewing around this issue. From Reuters.

A group of bondholders challenged Italy’s rescue of ailing bank Monte dei Paschi di Siena (MI:BMPS), suing the lender over the cancellation of their investments and calling for the bonds to be reinstated.

The Italian banking enquiry looked at the state of play yesterday and there are allegations of wrong doing pretty much everywhere as losses were hidden. Indeed Germany’s banking supervisor got dragged in as there are claims it kept back information on the derivatives contracts with Deutsche Bank.

Banca Carige

Next on the list there is this from Reuters this morning.

 Italy’s Banca Carige warned that its working capital is not sufficient to satisfy its own needs for the next 12 months, the lender said in he prospectus for its imminent capital increase.

Carige also said it had not yet received the final SREP assessment by the European Central Bank, adding it could not rule out a request by the authority for additional capital strengthening measures.

The bank secured backing from core shareholders and underwriters for a vital 560 million euro cash call in a last-minute agreement signed on Friday.

Creval

Here is IlSole from Sunday via Google Translate on this subject.

A 70% collapse in less than two weeks had not been taken into account by anyone in Sondrio. Yet that is what is happening in the title of Credito Valtellinese. The Lombard bank has seen its capitalization deflating from 280 million to 95 million in a dozen sessions. And triggering sales was the announcement of the same bank to raise a 700 million capital increase.

There are obvious issues in wanting an extra 700 million Euros when your value is 280 million let alone 95 million! Anyway the share price has seen better days as it has fallen by just under 6% to 1.38 Euros as I type this.

Banca Popolare di Bari.

In a former life I used to deal with quite a few Italian banks on behalf of Deutsche Bank and am straining my memory to recall if my trip to Bari included this one. Anyway times were seemingly much better than now if this letter quoted in i due punti in September is any guide.

An important letter sent by Federconsumatori Italia to the Minister of the Economy, to the Governor of Banca d’Italia and to the President of Consob ….
It reads on the Republic signing of Antonello Cassano ” The bank has ruined our lives, we want to go back our savings. ” It is a climate of anger and despair that one breathes in the headquarters of the Banca Popolare di Bari shareholder protection committee………Investigations by the Bari Public Prosecutor’s Office describe years of irregular management, loss accounts and abnormal loans. Heavy offenses challenged at the top of Bpb, by the association for delinquency and fraud until false statements in the prospectus.

Comment

There is much to consider here as this is happening at the wrong stage in the cycle as the Italian economy has improved ( 0.5% GDP growth in the third quarter) which should be supporting the banks. Some of the non performing loans will be improving. However contrary to the boasting of Finance Minister Padoan the low bailout figure for Italy was a form of denial as problems were hidden and then ignored meaning that they got worse. A factor in this has been Italy’s problem with the size of its national debt and an aversion to adding to it.So now we find ongoing troubles instead of improvement.

Also the ongoing crisis and subversion of Euro area rules has in my view contributed to the way that the ECB is now considering changes to deposit protection. There is an irony here as its President has a past deeply entwined with all this as not only was he Governor of the Bank of Italy but there is a clue in the way that the banking regulations are called the “Draghi Laws”! Here is how he sums up the current state of play.

The other trend is the growing resilience of the financial sector.

Just for clarity in officialese banks are always resilient up to the day they collapse. But Mario is bright enough to cover himself.

Clearly this trend hides some variation among banks, which is largely driven by differences in their business models.

Can anybody think of who he might mean?

 

The ECB has it successes but also plenty of problems

Let is continue the central banking season which allows us to end the week with some good news. As this week has developed there has been good news about economic growth in the Euro area.

The Federal Statistical Office (Destatis) reports that, in the third quarter of 2017, the gross domestic product (GDP) rose 0.8% on the second quarter of 2017 after adjustment for price, seasonal and calendar variations. In the first half of 2017, the GDP had also increased markedly, by 0.6% in the second quarter and 0.9% in the first quarter.

It has been a strong 2017 so far for the German economy but of course whilst analogies about it being the engine of the Euro area economy might be a bitter thinner on the ground due to dieselgate there are still elements of truth about it. But we know that a rising tide does not float all economic boats so ECB President Mario Draghi will have been pleased to see this about a perennial struggler.

In the third quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.5 per cent with respect to the second quarter of 2017 and by 1.8 per cent in comparison with the third quarter of 2016.

Of course Mario will be especially pleased to see better news from his home country of Italy especially at a time when more issues about the treatment of non-performing loans at its banks are emerging. Also this bank seems to be running its own version of the never-ending story, from the Financial Times.

A group of investors in the world’s oldest bank, Italy’s Monte dei Paschi di Siena, have filed a lawsuit in Luxembourg after it announced bonds would be annulled as part of a state-backed recapitalisation.

But in Mario’s terms he is likely to consider the overall numbers below to be a delivery on his “whatever it takes” speech and promise.

Seasonally adjusted GDP rose by 0.6% in the euro area…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro
area.

Inflation

This is a more problematic area for Mario Draghi as this from his speech in this morning indicates.

According to a broad range of measures, underlying inflation has ticked up moderately since the start of this year, but it still lacks clear upward momentum.

This matters because unlike the Bank of England the ECB takes inflation targeting seriously and a past President established a rather precise estimate of it at 1.97% per annum. We seem unlikely now to ever find out how Mario Draghi would deal with above target inflation but he finds himself in what for him maybe a sort of dream. Economic growth has recovered with inflation below target so he can say this.

This recalibration of our asset purchases, supported by the sizeable stock of acquired assets and the forthcoming reinvestments, and by our forward guidance on interest rates, helps to maintain the necessary degree of accommodation and thereby to accompany the economic recovery in an appropriate way.

So we will get negative interest-rates ( -0.4%) for quite a while yet as he has hinted in the past that they may persist past the end of his term. Also of course whilst at a slower rate ( 30 billion Euros a month) the QE ( Quantitative Easing) programme continues. Even that has worked out pretty well for Mario as continuing at the previous pace seemed set to run out of German bonds to buy.

Consequences

However continuing with monetary expansion into a boom is either a new frontier or something which later will have us singing along with Lyndsey Buckingham.

(I think I’m in)(Yes) I think I’m in trouble
(I think I’m in) I think I’m in trouble

Corporate Bonds

When you buy 124 billion Euros of corporate bonds in a year and a few months there are bound to be consequences.

“Tequila Tequila” indeed. What could go wrong with this.?

OK, we are officially in la la land. A BBB rated company just borrowed 500 million EUR for 3 years with a negative yield of -0.026 %. A first..  ( h/t @S_Mikhailovich )

You can take your pick whether you think that Veolia is able to issue debt at a negative interest-rate or at only 0.05% above the swaps rate is worse.

Mario Draghi explained this sort of thing earlier in a way that the Alan Parsons Project would have described as psychobabble.

By accumulating a portfolio of long-duration assets, the central bank can compress term premia by extracting duration risk from private investors. Via this “duration extraction” effect, the central bank frees up risk bearing capacity in markets, spurs a rebalancing of private portfolios toward the remaining securities, and thus lowers term premia and yields across a range of financial assets.

Moral hazard anyone?

The dangers of this sort of thing have been highlighted by what has happened to Carillion this morning.

The wages problem

It is sometimes argued in the UK that weak wage growth is a consequence of high employment and low unemployment. But we see that there are issues too in the Euro area where the latter situations whilst improved are still poorer.

A key issue here is wage growth.Since the trough in mid-2016, growth in compensation per employee has risen, recovering around half of the gap towards its historical average. But overall trends remain subdued and are not broad-based.

Indeed if we look back to late May Mario gave us a rather similar reason to what we often here in the UK as an explanation of weak wages growth.From the Financial Times.

Mr Draghi also acknowledged concerns that sinking unemployment was not leading to a recovery in well-paid permanent jobs………….Mr Draghi said he agreed. “What you say is true,” he said. “Some of this job creation is not of good quality.”

The Italian Job

As I hinted earlier in this piece there are ever more signs of trouble in the Italian banking sector. There have been many cases of can kicking in the credit crunch era but this has been something of a classic with of course a dash of Italian style and finesse. From the FT.

Mid-sized Genoan bank Carige’s future looked uncertain this week after a banking consortium pulled its support for a €560m capital increase demanded by European regulators. Shares in another mid-sized bank Credito Valtellinese fell 8.5 per cent to a market value of €144m after it announced a larger than anticipated €700m capital raising to shore up its balance sheet.

There are issues with banks elsewhere as investors holding bonds which were wiped out insist on their day in court.

Comment

As you can see there is indeed good news for Mario Draghi to celebrate as not only is the Euro area seeing solid economic growth it is expected to continue.

From the ECB’s perspective, we have increasing confidence that the recovery is robust and that this momentum will continue going forward.

The problem though is where does it go from here? Even Mario himself worries about the consequences of monetary policy which has been so easy for so long and is now pro cyclical rather than anti cyclical before of course dismissing them. But unless you believe that growth will continue forever and recessions have been banished there is the issue of how do you deal with the latter when you already have negative interest-rates and ongoing QE?

Also the inflation target problem is covered up by describing it is price stability when of course it is anything but.

Ensuring price stability is a precondition for the economy to be able to grow along a balanced path that can be sustained in the long run.

Wage growth would be improved in real terms if inflation was lower and not higher.

Also Mario has changed his tune on the fiscal situation which he used to regularly compare favourably to elsewhere.

This means actively putting our fiscal houses in order and building up buffers for the future – not just waiting for growth to gradually reduce debt. It means implementing structural reforms that will allow our economies to converge and grow at higher speeds over the long-term.

Number Crunching

This from Bloomberg seemed way too high to me.

Italy’s failure to qualify for the soccer World Cup finals for the first time in 60 years may cost the country about 1 billion euros ($1.2 billion), the former chairman of the national federation said.

Me on Core Finance

http://www.corelondon.tv/2-uk-growth-cap-unreliable-predictive-bodies-bad/