Saturday, 21 July 2018

Red Letter Day, or Red Herring?

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  • Peters 475px June 2014

Peters: Countdown over… but what will the ECB really do?

Wednesday afternoon was taken over by Bloomberg News reporting a “leak” out of the ECB which revealed a proposal to institute a bond buying programme of €50bn per month from April of this year through the end of 2016. That would, if adopted, put €1.1trn on the visible slate, €500bn of which would be pumped into the system by the end of 2015.

There was a mixed reception with one camp being disappointed that there will be no more than €500bn this year and not €600bn or even €750bn but the other camp was smiling as the aggregate amount of €1.1trn would be a bigger number than anyone had expected to see committed in writing, although it is still smaller than an open-ended programme. Far more to the point, why wait until April? What about February and March?

The latter can either be explained by the ECB – it is based in Frankfurt – wanting to and needing to beef up both front and back-office systems in order to cope seamlessly with, and to report efficiently on, the bond buying programme. Still, as another one of those Draghi specials, if everyone knows what’s coming, it is a good and as effective as it being there. Much of the work of QE – that is bringing down the international value of the euro and pushing government bond yields lower – has been done by the markets on no more than a nod and a wink from the monetary authorities.

Whether this is just one of a number of proposals which will be tabled in today’s meeting is not known. It might even have been nothing but a red herring. The one thing it is most certainly not is a model which any one of the hundreds of pundits who have been trying to second-guess the ECB had put forward.

I am not a great fan of the Davos Ski Weekend which doles out fine food and wines to luminaries who have flown in by private jet and chopper and who stay at five-star hotels in order to help them get in the right mood to discuss how to counter inequality. It does, nevertheless, have the advantage that there are enough opinion formers to hand to speak to radio and TV on the themes of the day and so it is that the BBC got its hands on Axel Weber, former President of the Bundesbank.

Weber, now Chairman of UBS, has always been a vocal opponent of QE and was quick to remind why. In the centre of his argument remains the observation that the ECB should do no more than buy time for national governments to reform their finances and their rigid labour markets. It cannot do it for them. Her argues that QE worked in the US and UK because they had to deal with nothing other than a cyclical downturn. Europe has deep-seated structural issues to deal with and all the cheap money in the world can do nothing to remove them.

Thus I wonder whether the ECB is doing nothing other that running up the white flag with a gentle, under the breath, “If you want your darned QE, then have your darned QE but then please leave us alone!” And then what?

“Risk on” on tap

If one is to buy the rumour and sell the fact, how come bond markets sold off sharply yesterday before the facts are known? I certainly would not have expected to see the 10-year Bunds trading back above 0.5%. On Tuesday morning it was at 0.43% and, having risen by 10bp yesterday, it is at 0.54% this morning. In price terms, that is give or take a full point of loss on the price of the bond which neatly wipes out two years worth of interest income as the current benchmark only carries 0.5% coupon. Yikes! Looks like another bout of “risk on” lies ahead.

One way or the other, there’s a strong sense that the “risk on” trade is the right one, the very opposite of what one would expect given the economic environment, but if the ECB is going to give away cheap money, who is mad enough not to pull their forelock, take it and run as fast as they can?

There remain many questions which will, in part at least, be answered when the ECB meeting ends and when whatever there is to announce is announced. Along with all the other interested ECB watchers I will have my abacus out but at the end of the day, you can’t use a calculator to measure sentiment. You also can’t argue that Axel Weber hasn’t nailed the problem. The SNB demonstrated last week what happens when political will alone is not enough.

PBoC on the case

Meanwhile, the People’s Bank of China has been in the money markets, injecting cash by way of reverse repos. This is not a measure it has employed in quite a while, and it is being seen by markets as the harbinger of even more stimulative action. I don’t think that anybody knows what the actual rate of growth in China is but it must be heading for well below the targeted 7.5% for the authorities to be digging quite this deeply into their tool-box.

Some economists – wise ones take all Chinese releases with a healthy pinch of salt – think it could be as low as 5% but seeing as that perception is reality, most of the world is happy to believe that it is only a near miss at around 7.3%.

The reverse-repo intervention was pretty significant at Rmb50bn but it is still just a gentle indicator that the PBOC isn’t going to mess around. In the midst of this, Premier Li Keqiang has repeated that he does not see a build-up of systemic financial risks. Well, he would, wouldn’t he.

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