While markets seem to be thinking about coordinated rate cuts next year, the truth is, economies are in very different positions, with New Zealand already looking stagflationary, and the ECB and the Bank of England not sharing the rate cut love exhibited by the FED. Norge Bank lifted this past week, and the RBA is still not close to a cut.
So we think the inflation poker game is fragmenting. The results will still be higher rates for many, for longer than the markets are signalling.
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Overnight we saw the Bank of England and the ECB lift the target rate by 50 basis points.
The UK story appears to be one where inflation is easing a little though growth prospects remain weak into the medium term. In the ECB, inflation is perhaps more troublesome, and further rate rises are anticipated. But both are seen by the market to be the peak of this raising cycle (though with risks to the upside).
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Well clearly most central banks got the 50-basis point hike memo, as following the Fed yesterday, with the Bank of England, the ECB and The Swiss Central Bank all hikes their rates by 0.5%. Markets reacted with significant falls, as the higher for longer mantra is threatening future earning, while Treasury yields fell across the curve. This all does put the RBA out of line given its recent 25-basis point rises and suggests we in Australia are behind the ball – significantly. Hey, but then of course Australia is different – right?
U.S. stock indexes finished sharply lower on Thursday with the Dow Jones Industrial Average logging its biggest daily decline in over three months, as investors continued to digest tough talk from the Federal Reserve on inflation that revived concerns about a potential U.S. recession.
In the UK, Bank of England Governor Andrew Bailey said he saw “good news” in UK inflation figures that ticked down from a 41-year high, but there was a concern that consumer prices could leap again and that the central bank has more to do to prevent a wage-price spiral. Speaking after policy makers lifted their key rate a half point to 3.5%, the highest since 2014, Bailey said the risk is that inflation sticks around longer that the BOE is anticipating.
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The ECB joins the rate rise club, with a 50 basis point hike – which was bigger than expected by the markets. They expect inflation to hang around, and they expect further normalization ahead.
So this marks the end of the negative interest rate experiment, other than in Japan, Denmark and Sweden. Banks will see profit uplifts as a result.
But the result will be higher rates around the world – until something breaks…
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The ECB joins the rate rise club, with a 50 basis point hike – which was bigger than expected by the markets. They expect inflation to hang around, and they expect further normalization ahead.
So this marks the end of the negative interest rate experiment, other than in Japan, Denmark and Sweden. Banks will see profit uplifts as a result.
But the result will be higher rates around the world – until something breaks…
Go to the Walk The World Universe at https://walktheworld.com.au/
To prevent its bond yields from rising, Italy needs a bailout now, not later. Specifically, it needs a dedicated firewall of at least €500 billion . This is because if bond yields were to rise too high too quickly, Italian public finances will deteriorate, and Italy will then be increasingly unable to roll over its debt.
The European Central Bank is the only authority with the wherewithal to finance this bailout. But they won’t at the moment.
The bond market has been pricing an implicit ECB guarantee concerning Italian sovereign debt. Thus, should the ECB fail to act this could become another global credit crisis trigger. So the ECB is basically being held hostage by the bond markets.
At present, the ECB only has the authority to purchase an additional €150 billion of Italian debt before it breaches the self-imposed 33% issuer limit. German and Dutch hawks on the ECB governing council have expressed opposition to even contemplating any breach of this ceiling. This impending bailout will test European political unity shortly.
The ECB must ride to the rescue over the objections of the fiscally upright German and Dutch council members, assuming all of the repugnant moral hazard that comes with that. The only alternative is an Italian default and subsequent “Italexit” that would send shockwaves reverberating throughout financial markets worldwide. And it would blow-up the Eurozone in a heart beat.
More stimulus from the ECB, including the purchase of non-financial commercial paper. Following Japan, UK and USA. But just pause, to ask how will yet more liquidity helps – sure it might move bond rates, but support for real households and businesses should now be the main focus. Repeating the past mistakes and expecting different outcomes is.. well, a little mad. “The ECB will not tolerate any risks to the smooth transmission of its monetary policy in all jurisdictions of the euro area”.
The Governing Council decided the following:
(1)
To launch a new temporary asset purchase programme of private and
public sector securities to counter the serious risks to the monetary
policy transmission mechanism and the outlook for the euro area posed by
the outbreak and escalating diffusion of the coronavirus, COVID-19.
This
new Pandemic Emergency Purchase Programme (PEPP) will have an overall
envelope of €750 billion. Purchases will be conducted until the end of
2020 and will include all the asset categories eligible under the
existing asset purchase programme (APP).
For
the purchases of public sector securities, the benchmark allocation
across jurisdictions will continue to be the capital key of the national
central banks. At the same time, purchases under the new PEPP will be
conducted in a flexible manner. This allows for fluctuations in the
distribution of purchase flows over time, across asset classes and among
jurisdictions.
A waiver of the
eligibility requirements for securities issued by the Greek government
will be granted for purchases under PEPP.
The
Governing Council will terminate net asset purchases under PEPP once it
judges that the coronavirus Covid-19 crisis phase is over, but in any
case not before the end of the year.
(2)
To expand the range of eligible assets under the corporate sector
purchase programme (CSPP) to non-financial commercial paper, making all
commercial papers of sufficient credit quality eligible for purchase
under CSPP.
(3) To ease the collateral
standards by adjusting the main risk parameters of the collateral
framework. In particular, we will expand the scope of Additional Credit
Claims (ACC) to include claims related to the financing of the corporate
sector. This will ensure that counterparties can continue to make full
use of the Eurosystem’s refinancing operations.
The
Governing Council of the ECB is committed to playing its role in
supporting all citizens of the euro area through this extremely
challenging time. To that end, the ECB will ensure that all sectors of
the economy can benefit from supportive financing conditions that enable
them to absorb this shock. This applies equally to families, firms,
banks and governments.
The Governing
Council will do everything necessary within its mandate. The Governing
Council is fully prepared to increase the size of its asset purchase
programmes and adjust their composition, by as much as necessary and for
as long as needed. It will explore all options and all contingencies to
support the economy through this shock.
To
the extent that some self-imposed limits might hamper action that the
ECB is required to take in order to fulfil its mandate, the Governing
Council will consider revising them to the extent necessary to make its
action proportionate to the risks that we face. The ECB will not
tolerate any risks to the smooth transmission of its monetary policy in
all jurisdictions of the euro area.
European Central Bank chief Christine Lagarde warned on Thursday that the coronavirus had delivered a “major shock” to the global economy that required urgent, coordinated action, as she unveiled fresh stimulus to keep credit flowing. Via France24
The
latest major central bank to jump into the fray, the ECB launched a
flurry of measures to cushion the impact of the virus, including
increased bond purchases and cheap loans to banks.
But it surprised observers by leaving key interest rates unchanged.
The Paris and Frankfurt stock exchanges extended earlier losses after Lagarde‘s announcements to post drops of more than 10 percent in the early afternoon.
“The spread of the coronavirus COVID-19 has been a major shock to the growth prospects of the global economy and the euro area,” Lagarde told reporters in Frankfurt.
“Even if ultimately temporary by nature, it will have a significant impact on economic activity.”
She
urged governments to step up and do their bit alongside monetary
policymakers as fears mount of a credit crunch that could destabilise
banks and hurt small businesses.
“Governments and all other policy institutions are called upon to take timely and targeted actions,” she said.
“In particular, an ambitious and coordinated fiscal policy response is required to support businesses and workers at risk.”
Whether
the eurozone manages to avoid a recession will “clearly depend on the
speed, the strength and the collective approach that will be taken by
all players,” she said.
Super-cheap loans
As
part of its stimulus package, the ECB’s governing council agreed a new
round of cheap loans to banks, known as long-term refinancing operations
(LTROs) “to provide immediate support to the euro area financial
system”.
They also eased conditions on
an existing “targeted” LTRO programme, aiming to “support bank lending
to those affected most by the spread of the coronavirus, in particular
small- and medium-sized enterprises”.
And
the ECB will pile an extra 120 billion euros ($135 billion) of
“quantitative easing” (QE) asset purchases this year on top of its
present 20 billion per month.
The QE
scheme will include “a strong contribution from the private sector,” the
ECB said, as room to buy government debt while respecting self-imposed
limits has grown tight.
On top of the
monetary measures, the ECB’s banking supervision arm said it would allow
banks to run down some of the capital buffers they must build up in
good times to weather crises.
Its teams
supervising individual lenders may provide more flexibility to
institutions under their remit, such as giving them more time to patch
up shortfalls in their risk management, while a broader range of assets
will count towards the watchdog’s capital requirements.
‘Bravo’
Ahead
of Thursday’s meeting, analysts had highlighted tweaks to the ECB’s
bank lending scheme in particular as a critical tool for virus response.
“Bravo!” Pictet Wealth Management analyst Frederik Ducrozet tweeted after the statement, hailing the ECB’s “bold decisions”.
Ducrozet
noted that under the changes to the TLTRO programme, lenders that loan
the cash they get from the central bank on to the real economy will
enjoy an interest rate potentially as low as -0.75 percent.
At
0.25 percentage points below the rate the ECB charges on banks’
deposits in Frankfurt, the difference represents an effective subsidy to
the financial system.
Meanwhile the
central bank dispensed with what many expected would be a purely
symbolic interest rate cut of just 0.1 or 0.2 percentage points.
The
US Federal Reserve last week and Bank of England on Tuesday had space
to cut interest rates by half a percentage point each to ease financial
conditions.
But the ECB’s already-negative deposit rate robbed it of that option.
Governments on hook
Lagarde
again reiterated the ECB’s long-standing call on governments to do more
with their fiscal powers to buttress the eurozone economy.
In
a conference call Tuesday with European heads of government, the former
International Monetary Fund (IMF) head “drew comparisons with past
crises” like the 2008 financial crisis, a European source told AFP.
Such past trials were overcome by central banks and governments working in concert.
In
mid-February, Lagarde reiterated that “monetary policy cannot, and
should not, be the only game in town” to stimulate the economy.
Italy
on Wednesday announced 25 billion euros of support to its economy and
the European Union has also mobilised up to 25 billion euros.
On 7 October, the European Central Bank (ECB) published its liquidity stress test results for 103 euro area banks. ECB’s increased focus on stressed liquidity is credit positive for these banks. As the liquidity coverage ratio (LCR) has a very short 30-day horizon, ECB looking at liquidity stresses lasting six months provides a much more meaningful measure. The test results will be used to strengthen the liquidity risk assessment in the 2019 Supervisory Review and Evaluation Process (SREP), but will not have a direct effect on capital requirements. Via Moody’s.
Overall, the stress test highlights a marked variation in euro area banks’ ability to cope with severe liquidity shocks. It demonstrated that there are pronounced pockets of vulnerability, with 75% of banks being unable to cope with a severe stress that lasted six months. While individual bank results were not released, the ECB stated that large universal banks and G-SIBs were the most exposed.
The ECB focused on idiosyncratic (rather than systemwide) shocks calibrated on the basis of recent liquidity crises. The effect was measured in terms of survival horizons by looking at banks’ cumulative cash flows and available counterbalancing capacity (i.e. the liquidity the banks can generate based on available collateral) in three scenarios. The scenarios include a baseline, in which the bank is no longer able to tap the wholesale funding market; an adverse shock, which adds a limited deposit outflow, limited withdrawals of committed lines, and a one-notch rating downgrade; and an extreme shock scenario, which adds severe deposit run-offs, pronounced withdrawals of committed lines, and a three-notch rating downgrade.
Overall, the banks’ reported median survival period was 176 days, or almost six months, under the adverse shock scenario and 122 days (just over four months) in the extreme shock scenario. Only 25% of the banks have liquidity buffers that would withstand the extreme shock scenario for six months or longer, and the majority (75%) have a survival period that is shorter than six months. Survival periods varied markedly, with differences driven mainly by the banks’ funding mix.
There are significant pockets of vulnerability. Although results for individual banks have not been disclosed, four banks from different jurisdictions and with different business models have a survival period of less than six months even in the baseline scenario, which we consider very weak, and 11 banks have a survival period of less than two months under the extreme shock scenario. Universal banks and global systemically important banks (G-SIBs) are also harder hit by the stress scenarios.
Exhibit 2 shows the (simple average) effect of the three scenarios compared to the initial stock of net liquidity, with overall outflows equivalent to around 27% of total assets under the extreme scenario. The key effect under the baseline scenario is caused by the lack of access to wholesale markets, followed by deposit withdrawals under the adverse and extreme scenarios.
Although any stress test must be based on assumptions and scenarios, we note that past liquidity crises (according to the ECB’s stress test announcement in February 2019) lasted between four and five months on average. However, 43% of the real life stresses lasted longer than six months. With a median survival horizon of a little longer than four months, many banks may have a survival horizon that may prove short, particularly in a bank-specific crisis with more limited opportunities for the central bank to intervene with extraordinary measures. It also points to the need for banks to mobilize additional non-tradable collateral in addition to the readily available liquidity buffers, which is one of the areas where the ECB observed scope for improvement.
Universal banks and G-SIBs, which are generally more reliant on less stable deposits and wholesale funding, despite having large liquidity buffers, were the hardest hit by the stress scenarios. Their median survival in the adverse shock scenario was 126 days, and 80 days in the extreme shock scenario.
Small domestic and retail lenders, which generally benefit from more stable deposits and lower reliance on wholesale funding, were relatively less affected. Their median survival was more than 180 days under the adverse shock scenario and was 140 days under the extreme shock scenario, indicating that they would maintain positive liquidity for significantly longer than the universal banks and G-SIBs. The results are in line with our assessment where large banks often have weaker funding and liquidity assessments compared to smaller domestic retail banks. Exhibit 3 shows the counterbalancing capacity and the liquidity outflows per type of bank, with G-SIBs/universal banks significantly more negatively affected compared to small domestic/retail lenders.
The stress test also identified vulnerabilities related to cash flows in foreign currencies, where survival periods generally are shorter than those reported at consolidated level. Whereas the median survival period in EUR was 125 days, the median survival periods in USD and GBP were 57 and 53 days, respectively. This suggests that the lessons during the global financial crisis have not been fully learnt. In addition, some banks’ collateral management practices, which are essential in the event of a liquidity crisis, also need improvement.
The ECB also cautioned that banks may underestimate the negative effect that a credit rating downgrade could trigger. Previous liquidity crises have shown that deteriorations can go quickly and fast.
