Europe Quantitative Easing
This is a guest post from Richard Koo, chief economist of the Nomura Research Institute and, amongst many other things, author of “The Holy Grail of Macroeconomics, Lessons from Japan’s Great Recession”, which lays out his balance sheet recession thesis in detail. The post is an updated extract from his most recent note for Nomura and reproduced here, with his permission, for your arguing pleasure… The US, the UK, Japan, and Europe all implemented quantitative easing (QE) policies, but the understanding of how those policies work apparently differs greatly from country to country, leading to very different outcomes. With the US economy doing better than the rest, there has been some debate in Europe as to why that is the case.
A new era – German 10-year bund yield drops below zero for the first time: pic.twitter.com/XJAoFDZ3mE — Tracy Alloway (@tracyalloway) June 14, 2016 Yeah. Fun. This is also fun: Make that 50% of Bunds no longer eligible to ECB QE! (€400bn out of €810bn) pic.twitter.com/y8qP7fHk3c — Frederik Ducrozet (@fwred) June 14, 2016
It’s all a bit messy at the moment — European banks, Japanese banks post the BoJ’s move negative, er other stuff — but it’s not really clear what’s actually going on. This seems like a decent list of possibilities, from Citi’s Steven Englander: We think the following concerns are weighing on the market. 1. US economic fragility means there is no one to depreciate against 2. Too many simultaneous issues and policy coordination unlikely. 3. QE/negative rates have lost their financial market impact, 4. QE/negative rates have lost their economic impact 5. QE/negative rates are constrained by bank profits But his colleague Matt King has a somewhat more involved, if not entirely separate, explanation for what he says is, at the surface, an orderly sell-off but which hides a number of indicators under “extreme stress”. Basically, it’s all about bank balance sheets coming under pressure. Less basically, he suggests these dislocations “raise awkward questions about the entire narrative which led to the wave of post-crisis bank regulation.”
ICYMI, and on the back of the BoJ going negative, “the universe of DM government bonds trading with a negative yield rose to a record high of $5.5tr, or 24% of the JPM Global Government Bond Index,” according to JPM.
Here’s the Fed’s recent hike in context, courtesy of BofAML’s Hartnett et al. You might need to squint… When you’re done squinting, you might also dwell on the fact that long-term rates matter much more than short-term rates in the US and that we might be about to enter “conundrum” territory once again,
A tiered depo rate (to be explained below) coming from the ECB at their meeting on Thursday, you say? Allowing them to potentially push past the expected (per our inboxes) coming cut in the depo rate by 10bps to -0.30 per cent, alongside other easing measures? Well… the mooted tiered system itself wouldn’t be unprecedented and we look forward to even the expected cut allowing our go-to measure of euro-nuttiness to keep ticking up. From JP Morgan’s Niko Panigirtzoglou and team over the weekend:
We’ll be slamming up the best of our collective inbox on matters Greece as and when the good stuff pours in. Catching up on the last few hours, here’s JP Morgan’s Greg Fuzesi:
Some of you may remember how the ECB fecked up last week, when “an internal procedural error” meant an eventually market moving speech given by one Benoît Coeuré on Monday to, amongst others, a load of hedgies wasn’t made public until Tuesday morning. The speech — apart from starting a debate about Chatham House rules, priviliged information and knee jerk responses by the ECB — was about ECB plans to front-load their bond purchases in May and June. And as Citi’s credit specialist Matt King said: “If the ECB had wanted to test the extent to which traders were hanging on their every word, they could hardly have come up with a better experiment than to promise to boost the pace of QE purchases today, only to cut it back during the summer.”
The long awaited, much predicted start of the great turning point in bond markets after which yields will rise, prices fall and teeth gnash has arrived. Maybe. We have had a moderate bit of violence and surprise in fixed income, after all. A sample of sentiment below, but a word of caution up front: higher volatility might have caused the market moves, meaning the big reaction is still to come and/or potentially distant. Here’s Jens Nordvig of Nomura late on Tuesday:
On the back of news “that several Chinese provincial governments have been forced to postpone bond auctions as banks balk at the low yields on offer” — really scuppering the plans of those local governments to restructure their massive debts — some rumours of “Chinese QE” began floating about over the past few days. But that seems to have passed…. and now it’s chatter of an ECB style LTRO that’s being heard in the wind. Either way though, we think it would be a better idea to forget the QE or LTRO comparisons this time around — it muddies the water — and instead concentrate on what China is trying to achieve.
We were too distracted by wardrobe-malfunctioning protesters to pay proper attention to what Draghi was saying. Luckily, we’ve just gone through the meeting summary from Greg Fuzesi at JP Morgan and it seems one of the key takeaways was probably this: Draghi also dismissed concerns about bond scarcity as premature. He said that the ECB was not encountering any problems so far in making the intended volume of purchases and he added that the programme was flexible enough to adapt to any problems that might emerge. But, apart from again ruling out a cut in the deposit rate as a way of raising the amount of bonds that can be purchased, he did not say which aspects of the programme could be changed in the future, if needed.
In its implementation of the PSPP, the Eurosystem intends to conduct purchases in a gradual and broad-based manner, aiming to achieve market neutrality in order to avoid interfering with the market price formation mechanism… – ‘Implementation aspects of the public sector purchase programme’, European Central Bank
Last week we got a Draghi-backed report by the ESRB which challenged the risk-free treatment of sovereigns by banks. It included such insights as “the evidence presented in the report illustrates, however, that sovereign risk is not a novel concept” and “If sovereign exposures are in fact subject to default risk, consistency with a risk-focused approach to prudential regulation and supervision requires that this default risk is taken into account”. Which, you know, makes sense. Thing is though, it doesn’t seem like the bank-sovereign nexus is going anywhere fast. As Gary Jenkins put it: The tone suggests that the ESRB would like to see a change in the regulatory regime although it is clearly a case of ‘Give me chastity, just not yet,’ as this is also the week that the ECB began its QE programme without differentiating on risk between 3 year or 30 year bonds. They have set a yield of -0.2% as where they are prepared to buy anything. Thus technically holders of 30 year bunds could say that is the level they are prepared to sell at.
“It’s official, there are no more sellers of bonds.” An investor told us yesterday, and he’s not alone. Bond buying on ECB QE, the Greek loan extension and recent growth data in the periphery has transformed itself into bond hoarding. - RBS’ Alberto Gallo and team
A question worth asking considering the rather large amount of them knocking about at the moment. According to JPM, the total universe of government bonds traded with a negative yield was $3.6tr last week or 16 per cent of the JPM Global Government Bond Index. It’s an answer in itself, really. Anyway, here’s a list of those willing/ forced to buy those negative yielding government bonds from JPM’s Niko Panigirtzoglou:
Sometimes the simplest explanation is the only one needed, and in economics it doesn’t get much simpler than supply and demand. Competing reasons have been offered for the sustained, vigorous decline in 10-year and long-dated US Treasury yields despite the acceleration in the economic recovery since last spring. Most recently the sharp drop in yields has coincided with the stunning fall in oil and long-term inflation expectations, which boost real yields and thus make Treasuries more appealing.
The Bank of Canada cut rates yesterday and the European Central Bank announced its sovereign bond-buying scheme today. In both cases, there were sharp responses in the currency markets, but they seem to have cancelled each other out:
Barack Obama’s State of the Union address sought to capitalise on the resurgent economy to win support for his progressive policies, but Republicans were quick to point out that many Americans have yet to feel the benefits. Pointing out that the president’s overview might not be completely objective, the NYT’s Upshot did their own analysis of the State of the Union – stronger than when Mr Obama took office, but still troubled. (FT, NYT) When a Democratic president talks up “transgender” rights in prime time, you can be sure he does not face re-election. His real game was to set the field for Hillary Clinton’s election victory next year, which is also Mr Obama’s best hope of cementing his legacy, writes Ed Luce. (FT)