Monday, October 26, 2015
Mario Draghi’s bold comments have raised the bar for the December meeting to a very high level. What could the ECB actually do? Even after some sleep and several internal brainstormings, it is not fully clear to us why ECB Draghi went as far as he did with his comments during Thursday’s ECB press conference. In our view, it would have been more than sufficient to use the phrase “the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting”. This alone would have been a clear opener for more monetary action in December. Instead, Draghi himself brought forward the possibility of lowering the deposit rate, mentioned that some Governing Council members had already been in favour of more action at the Thursday meeting and hinted at new, unprecedented action by stating that the Governing Council had tasked internal committees to investigate further measures. All in all, a “work-and-assess” mode that has put market expectations to a (too) high level. The question of why Draghi chose for such boldness will remain unanswered. Is the ECB just overly concerned or are we back in the good old days when central banks had exclusive insight information on markets and economies? Hopefully, the meeting minutes will shed some light on these questions. Looking ahead, all eyes will now be on the 3 December meeting. In our view, despite all boldness, new action is not a done deal, yet. It will be conditional on the next batch of ECB staff projections and, particularly, the inflation forecasts for headline and core inflation in 2017 (1.7% and 1.6% respectively in the September forecasts). Admittedly, inactivity in December would clearly be counterproductive and would lead to a negative market reaction, eventually still forcing the ECB to act. In short, Draghi’s boldness has put the ECB into a position from which it will be very hard to escape without any new action. Based on Draghi’s comments on Thursday, what is the most likely action the ECB can deliver on 3 December? Given that not all members of the ECB’s Governing Council seem keen on stepping up QE, as they either deem it too early or simply ineffective (just think of Liikanen or Weidmann), returning to traditional monetary policy instruments seems like the most viable option. A cut of the deposit rate by 5-10 bp and a cut of the refi rate to zero could be easier digested by the ECB’s own QE critics. The fact that Draghi had several prepared statements at the Thursday meeting on why a rate cut would not lead to a credibility loss (despite last year’s comments that the ECB had reached the lower bound) and the focus on real not nominal rates, suggests that the ECB did already have a very intense discussion on this option. Draghi’s comments that the Governing Council had tasked all relevant committee to investigate other possible measures suggests that the ECB itself is not fully concerned that a simple “more of the same” will do the trick. Stepping up the current QE by either increasing the monthly size or the length of the programme is on the one hand hard to achieve (given that markets have already dried up significantly) and on the other hand will probably not have a huge impact on the economy. In our view, however, it is doubtful that the same committee which prepared QE last year will now all of a sudden find completely new measures no one else had ever thought about before. In theory, possible options might be purchases of corporate bonds, stocks or government bonds of non-Eurozone countries. Is it likely? In our view, not (yet). Notwithstanding the above, the ECB might still be tempted to deliver something on QE. Just in order to meet high market expectations. In this regard, some minor, rather cosmetical, changes to the current QE programme should not be excluded. An increase of the monthly size by 5 to 10bn and an extension of the minimum deadline to January 2017, instead of the current September 2016. The ECB might even consider dropping the reference to a precise minimum deadline. At first glance, this would make the programme look more open-ended than it currently is. However, at second glance, such a move could backfire in a situation in which inflation expectations start to increase before September 2016. Another more elegant way to do something more in terms of QE (probably preferred by the members of the Governing Council more critical of the programme) would be lowering the minimum yield at which the ECB can purchase bond (currently -20 bp), in line with the rate cut on the deposit facility (given the fact that it is not entirely clear whether there is an automatic link between deposit rate and the rate limit for QE purchases). That could also shift the longer end of the yield curve downwards. In the same vein, a further rate cut on TLTROs could be considered. All in all, a rate cut (also applied to the different types of unconventional monetary policy instruments), possibly combined with some cosmetic tweaking of QE look like the most likely next step for the ECB. Will it help? The ECB thinks it does. And, indeed, judging from Thursday’s market reaction, it should – at least initially – weaken the euro exchange rate. However, as it always needs two to tango, this ECB strategy would only work if the Fed would really start hiking interest rates. In this regard, any market and ECB enthusiasm could easily end with a hangover two weeks later when the Fed meets on 16 December.
Surprised but not frightened? German businesses showed an interesting reaction to the recent series of uncertainties and turmoil. In fact, the reaction can be summarized as impressed but not frightened. Germany’s most prominent leading indicator, the just released Ifo index dropped to 108.2 in October, from 108.5 in September. The first drop since June this year. Interestingly, the drop was exclusively driven by a weaker assessment of the current situation. The expectation component, on the other side, increased to 103.8, from 103.3, continuing its recent positive trend and actually reaching the highest level since June last year. Of course, one should not interpret too much in a single confidence indicator but today’s Ifo reading suggests that the German business community is filing the Volkswagen scandal as a one-off and also shrugs off the risk from a possible Chinese and emerging markets slowdown. Despite these external uncertainties and regular concerns about the real strength of the German economy, German business remain highly optimistic. There are two possible explanations for this trend: either German businesses are naive optimists or ice-cold realists, sticking to the facts. In our view, there are many arguments in favour of the latter. Admittedly, the latest drop in new orders and shrining order books has dented some optimism on the outlook for the German industry. However, continued growth in the service sector, strong domestic demand and an outside world that might be slowing but is definitely not falling off a cliff, should keep the German economy on the sunny side. Finally, let’s not forget that the German economy is one of the largest beneficiaries of the ECB QE programme, taking immediate support from a weak euro and low interest rates. Needless to say, not all is well in the land of cars. The lack of new structural reforms, the unfinished energy reform and too few domestic investments will eventually hit the economy. Moreover, the inflow of refugees, while being short-term stimulus for domestic demand, is the biggest challenge for Germany in decades, posing both enormous risks and opportunities, but in anyway asking for unprecedented and lasting flexibility of both the society and the economy. All in all, today’s Ifo index shows that the German economy is not totally immune against external slowdowns and internal scandals. However, there is no reason at all to fear an abrupt slowdown of the Eurozone’s biggest economy
Thursday, October 22, 2015
Back to back with one of Malta’s biggest casinos, the ECB today clearly increased its bets, sending strong hints on new monetary stimulus at the December meeting. While no decision was taken today, the ECB’s sounded more concerned about the growth outlook for the Eurozone and signaled its willingness to act. According to ECB president Draghi, some members of the Governing Council were already willing to act today. As regards the macro-economic assessment, the ECB voiced more concerns about the growth outlook. Back in September, market turmoil and the slowdown of China and emerging markets were still too fresh to be integrated in the ECB’s projections. Today, the ECB singled exactly these factors out as the main risk for the Eurozone economy. To be precise, the ECB warned that “concerns over growth prospects in emerging markets and possible repercussions for the economy from developments in financial and commodity markets continue to signal downside risks to the outlook for growth and inflation. Most notably, the strength and persistence of the factors that are currently slowing the return of inflation to levels below, but close to, 2% in the medium term require thorough analysis.” Against the background of increased concerns about growth, and related second-round effects on inflation, ECB president Draghi opened the door to more monetary stimulus in December. In this regards, the key statements at today’s press conference were “the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting” and that the ECB already today had a “rich discussion and was “open to a whole menu of monetary policy instruments”. Draghi remarked that the ECB had tasked several committees to work on the implementation of possible instruments. He called this a “work-and-assess” stance. Finally, Draghi also mentioned a lowering of the deposit rate as a possibility for future action, even though back in 2014 he had announced that interest rates had reached the lower bound. Obviously, it is hard not to see the ECB’s intention to add more monetary stimulus. Still, the ruthlessness with which Draghi sometimes tried to defend the ECB’s position was a bit surprising. In fact, the ECB is still only one third into its envisaged QE purchases and the discussion on whether low (or even negative) inflation rates are now a curse or a gift for the Eurozone remains unclear. Furthermore, it is also far from certain that the marginal gains from stepping up QE are still positive. Judging from the immediate market reaction, stepping up QE should at least weaken the euro somewhat. In our view, probably the biggest and most important goal of the ECB as it would deliver almost instant success. Even though Draghi repeated the ECB’s well-known position that the exchange rate was obviously not a policy target for the ECB. All in all, Draghi has been more explicit than we had expected. The door for more monetary stimulus is wide open and does not necessarily have to be more QE. It could also be a lower deposit rate, maybe even fx interventions or purchases of other assets (previously excluded). Draghi’s u-turn on the lower bound of interest rates has made him walk in the footsteps of former German chancellor Adenauer who once said “why should I care about my chatter from yesterday”. So everything is possible. In our view, the main triggers for more action in December will be the ECB’s staff projections, particularly the headline and core inflation forecasts for 2017. Even though market participants should know from recent experiences with the Fed that crucial and groundbreaking decisions can be postponed more often than markets believe, it will be hard for the ECB not to deliver in December. Maybe inspired by the casino next door, the ECB today increased its bets. The ECB has to have strong cards, because it will have to show its hand in December.
Wednesday, October 21, 2015
At least they are trying. Today, the European Commission presented its plans on how to get the monetary union on a more sustainable footing. The Commission released a so-called policy package, trying to bring parts of the “Five Presidents’ Report” into life. To be clear, the Commission aims at implementation by mid-2017. Afterwards, stage 2 should start, which according to the Commission would include “more far-reaching measures”, which will “inevitably involve sharing more sovereignty and solidarity”. Even though the Commission states that its proposals are the result of extensive consultations with Eurozone member states, the European Parliament and stakeholders (whoever this might be), past experience has shown that these proposals are likely to be watered down in the coming months. Looking at the details, the Commission has tried to address all relevant issues, which would make the monetary union more sustainable: increase competitiveness, more supervision of national fiscal policies, a fully-fledged banking union and a common Eurozone voice in international for a. The concrete proposals, however, suggest that the courage to really make a huge step ahead was missing (or probably better said: the room was simply not given by national governments). Concrete, the Commission proposes national Competitiveness Boards, a European Fiscal Board, a more streamlined process for setting up national budgets combined with European supervision, the full implementation of the Bank Recovery and Resolution Directive and the directive on Deposit-guarantee schemes and, last but not least, a common representation of the Eurozone at the IMF. From a negative angle, the Commission proposals are mainly of a cosmetical nature and have a high “old wine in new skins” portion. Only the common representation is new and groundbreaking. Setting up new boards or committees could be regarded as window-dressing and it is doubtful that this really leads to stricter implementation of necessary reforms. The intentions are good but who does still remember the fiscal compact or national debt-brakes? From a positive angle and to give the Commission some credit, however, they at least tried. The Commission’s proposals are a very gentle, probably too gentle, push towards more political union. It is probably already the smallest common denominator across national governments. Let’s face it, the appetite for quantum leaps towards a political union is currently simply not strong enough.
Tuesday, October 6, 2015
“I know what you did last summer…”. German industrial production disappointed in August, dropping by 1.2% MoM, from +1.2% MoM in July. On the year, industrial production is still up by 2.3%. The drop was widely spread across all sectors. Only the production of intermediate goods remained flat. The sharpest declines were recorded in the production of capital goods and energy. The German industry is still struggling to gain momentum. Yesterday’s drop in new orders already signaled a note of caution. The August drop marked the first decline for two consecutive months since the beginning of the year. A clear sign for caution. Over the last couple of months, the industrial safety net of low inventories and filled order books has become thinner. Somehow, the weak euro and extremely favourable financing conditions have not fully deployed their full impact on the economy, yet. Since the end of last year, industrial production has remained flat. In the same period, exports have grown by 1% on average each month. Strong confidence indicators, sluggish production and booming exports. This seems to be the new conundrum of the German economy. All in all, today’s weak industrial production data will again give rise to speculation that the German economy is suffering from the Chinese slowdown. In our view, however, there is no need to panic. Just remember last summer when the German industry went through a similar period of weak data. In the end, the batch of disappointing data was rather the result of too many Germans enjoying too much vacation than the beginning of a downward trend. Let’s hope that history repeats itself.