Out of the Box: I Got a Pocketful of Kryptonite
I am getting prepared, you see. September is just around the corner and it will be the last European Central Bank meeting presided over by Mario Draghi, the Superman of Europe. My sense is that it is going to be one last, “Whatever it takes,” as virtually all of the economies of Europe are having serious trouble. Super Mario, in my opinion, is going to jump in, once more, to save the day.
Therefore, for money managers, Kryptonite, is an essential part of the preparations, as I am expecting a “shock and awe” meeting. The current ECB interest rates on its main refinancing operations, marginal lending facility and deposit facility sit at 0%, 0.25% and -0.40% respectively. I expect all of them to be lowered and perhaps substantially lowered. However, that may well just be the beginning of it.
TLTROs (targeted long-term refinancing operations) are loans intended to make the Eurozone’s banks lend more to the real economy. They have a negative deposit rate, so the ECB would pay lenders for taking the cash, meaning it’s a strong incentive for the banks to use them. The ECB’s third iteration of TLTRO is due to start in September, with the interest currently set at 10 basis points, which might be lowered to Zero, or less, in the current environment.
Also, I am expecting the introduction of a tiered rates, specifically to banks with significant excess liquidity. EU banks are currently paying some 7 billion Euros ($7.8 billion) per year to the ECB on cash parked there that exceeds mandatory reserves. This would rise to 8.8 billion Euros, if the deposit rate was cut to -0.5%, according to Reuters calculations. Nothing is known, with any certainty, about what the ECB’s tiered system might look like. But experience with similar schemes, from Japan and Switzerland, suggests it may worth between 4.4 and 6.6 billion Euros per year, assuming a 10-basis-point rate cut and depending on how it is designed.
“The Governing Council has tasked the relevant Eurosystem Committees with examining options, including ways to reinforce its forward guidance on policy rates, mitigating measures, such as the design of a tiered system for reserve remuneration, and options for the size and composition of potential new net asset purchases.”
-ECB policy statement
Allow me to explain the meaning of “net asset purchases.” This is “Quantitative Easing,” in polite terms. I think the ECB is about to start QE up again, and increase the size of it, and possibly the scope. I believe they are going to buy even more sovereign and corporate bonds, than in the last round, and this may include even non-investment grade bonds. Fourteen High Yield bonds, now in Europe, are trading at less than Zero presently. The effect of all of this will be to push down European yields even further into the “Sub Zero” space, from where they are currently.
At the outside, as suggested by BlackRock, they could start buying equities and ETF’s. They would be following the Swiss and Japanese paradigms, which are already firmly in place. You see, the ECB will make the money from nothing, take it and buy bonds, and maybe stocks, all so that the nations, that they represent, can afford their budgets and social programs because they can’t be afforded in any other manner, and to keep their equity markets afloat. At some point, I would argue, that this will get played out in the currency markets, as people realize just how serious the financial decline of Europe is these days. What cannot be afforded, can now be afforded, all by the creation of the “Pixie Dust Money” and then the use of it.
The ratings agencies, I point out, are doing us no favors. Just as they botched the CDO ratings, prior to the 2008/2009 financial debacle, they are botching up the sovereign ratings in Europe by not including the indebtedness of the European Central Bank, as they rate the various European nations. The ECB is now providing such a serious amount of Europe’s funding that I believe the ratings agencies should add the debt at the ECB into the mix. I am not saying that they should not do this for the United States, as well, but Europe is likely to push the needle to the point where it needs to be done to make their ratings credible.
Then there is “Brexit” and “Italgo,” also pushing on the European Union. Italian deputy prime minister, Matteo Salvini, on Saturday, denied he has plans to take Italy out of the Euro. Salvini’s League tops opinion polls and is favored to win a snap election that will likely take place this fall. Now what did you expect him to say? Of course, he said that, because after he wins the Italian elections, he will demand this and that from the EU, which Berlin and Brussels will reject, and then he can claim that Italy was forced out of the European Union, absolutely forced. It is just political blather, that he finds useful for the moment, a head fake.
Unfortunately, I see the “Game of Thrones” widening, with the onset of the ECB’s new dictums. On one hand, it will be the tariff struggle with China and I see a new battle front with Europe, opening up, with an interest rate skirmish. With China tariffs are the lever and with Europe interest rates are the lever, as everyone postures for prominence and position.
Gird for battle!
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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