Market reaction to the ECB announcement

by Sober Look

The ECB rolled out the big guns today but stopped short of an all-out quantitative easing. In addition to the TLTRO, there will be ABS and mortgage bond purchases. However these markets are relatively small in Europe – particularly the higher rated paper that would qualify for the ECB purchases.
The deposit rate on bank excess reserves was set to -20bp. With Germany continuing to resist full QE, Draghi’s best two options are to try stimulating consumer and business credit (via ABS purchases and TLTRO) as well as to push down the euro (via negative deposit rates). So we got a “bazooka lite”.
The euro took the biggest single-day hit in over two years in response to the decrease in deposit rate.

And the French 2-year government bond yield went negative for the first time.

But without the full QE in place, longer dated bond yields actually increased, as yield curves steepened. This carried over to the US where long-term yields rose as well.

And by the way here is one reason Germany remains uneasy with an all-out QE program –

Source: ECB

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Wall Street Called A Rally, But No One Came

By Steven Russolillo

Trading volume on the major U.S. exchanges suffered the slowest August since 2006, according to Credit Suisse CSGN.VX -1.52% Trading Strategy. And it got even slower as the month wound down: The final six trading days last month ranked among the lowest 15 volume days of the past seven years.

“What makes it feel even slower, though, is how much volumes dropped compared to the beginning of the year,” said Ana Avramovic, an analyst at Credit Suisse.

She notes that the first four months of the year saw higher volumes than the equivalent periods in 2012 and 2013. But as the chart below shows, average daily volumes this year started slumping in May and have only fallen further since.

The slowdown in trading over the past several months comes as investors see little reason to make big changes to their portfolios. Major U.S. stock indexes keep climbing to fresh records amid a growing economy and improving corporate profits.

Diminished volatility has played a role in keeping trading down. Volume from high-frequency trading also dropped significantly over the summer, according to Credit Suisse, continuing a years-long downtrend from the 2009 peak.

Overall, year-to-date trading volumes across U.S. exchanges are down 1.6% from a year ago, Credit Suisse says. At the moment, there’s little indication that the trend of low trading activity will change anytime soon.

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The Monetary Stimulus Obsession: It Will End In Disaster

by Detlev Schlichter

It is now six years since the collapse of Lehman Brothers, and considering that the US economy has officially been in recovery for the past five years, that equity indexes have put in new all-time highs, and that credit markets are once again ebullient to the point of carelessness, it is worth contemplating that monetary policy remains stuck in pedal-to-the-floor stimulus mode. Granted, quantitative easing is (once again) scheduled to end, and the first rates hikes are now expected for next year, but the present policy stance certainly remains highly accommodative. A full ‘exit’ by the Fed is still merely a prospect.

Expectations appear to be for the US economy to finally emerge from its long stay in monetary intensive care healthier and fit for self-sustained, if modest, growth. I think this is unlikely. The lengthy period of monetary stimulus will have saddled the economy with new dislocations. And if central bank intervention did indeed manage to arrest the forces of liquidation that the crisis had unleashed, then some old imbalances will also still hang around.

“Easy money” is – contrary to how it is frequently portrayed – not some tonic that simply lifts the general mood and boosts all economic activity proportionally. Monetary stimulus is always a form of market intervention. It changes relative prices (as distinguished from the ‘price level’ that most economists obsess about); it alters the allocation of scarce resources and the direction of economic activity. Monetary policy always affects the structure of the economy – otherwise no impact on real activity could be generated. It is a drug with considerable side effects.

The latest crisis should provide a warning. As David Stockman pointed out, it did not arrive on a meteor from space, but had its origin in distortions in the housing market in the US – and the UK, Spain and Ireland – and in related credit markets, and therefore ultimately in the “easy money” policies of the early 2000s. Administratively suppressing short rates down to 1 percent for a prolonged period was then the “unconventional” policy du jour, and it was a success of sorts. A credit crunch and deleveraging were indeed avoided, which were then feared as a consequence of WorldCom and Enron defaulting and the dot.com-bubble bursting, but only at the price of blowing an even bigger bubble elsewhere.

This is the problem with our modern fiat money system. With the supply of money no longer constrained by a nature-given, scarce commodity (gold or silver), but now fully elastic, essentially unlimited, and under the control of a lender of last resort central bank, the parameters of risk-taking are forever altered.

Allegedly, we can now stop bank-runs and ignite short-term growth spurts, or keep the overall “price level” advancing on some arbitrarily chosen path of 2 percent. But we can achieve all of this only through monetary manipulations that must create imbalances in the economy. And as the overwhelming temptation is now to use “easy money” to avoid or shorten any period of liquidation, to go for all growth and no correction, distortions will accumulate over time.

As we move from cycle to cycle, the imbalances get bigger, asset valuations become more stretched, the debt load rises, and central banks take policy to new extremes to arrest the market’s growing desire for a much needed cleansing. That policy rates around the world have converged on zero is not a cyclical but a structural phenomenon.

Central bank stimulus is not leading to virtuous circles but to vicious ones. How can we get out? – Only by changing our attitudes to monetary interventions fundamentally. Only if we accept that interest rates are market prices, not policy levers. Only if we accept that the growth we generate through cheap credit and interest-rate suppression is always fleeting, and always comes at the price of new capital misallocations.

The prospect for such a change looks dim at present. Last year’s feverish excitement about Abenomics and this year’s urgent demands for Eurozone QE show that the belief in central bank activism is unbroken, and I remain sceptical as to whether the Fed and the Bank of England can achieve a proper and lasting “exit” from ultra-loose policy in this environment. The near-term outlook is for more heavy-handed interventions everywhere, and the endgame is probably inflation. This will end badly.

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Deflazione, non è una fatale maledizione divina

by Guido Ascari

La deflazione è un pericolo reale per l’Eurozona: unita alla stagnazione può diventare una tenaglia letale per i paesi con alto debito pubblico. Uscirne si può, a patto di vincere alcuni tabù. Per esempio, avviando una politica di investimenti pubblici finanziata direttamente dalla Bce.

LO SPETTRO DELLA DEFLAZIONE

Uno spettro si aggira per l’Europa: la deflazione. In Italia è già diventato realtà e la tenaglia di stagnazione e deflazione è letale in particolare per paesi a elevato debito pubblico, come il nostro. Nell’area euro i prezzi sono da troppo tempo in continuo rallentamento e senza un intervento chiaro, credibile e massiccio, lo spettro si manifesterà anche a livello europeo.
Spesso, nei commenti giornalistici (e non solo) sembra che la deflazione sia una maledizione divina, mentre è importante che i cittadini europei sappiano che la deflazione è un scelta di (non) policy.
La maggior parte degli economisti ormai concorda che in Europa la situazione di stagnazione più deflazione sia causata da una carenza di domanda. La crisi ha determinato un fiorire di studi su economie in condizioni di trappola della liquidità e di tassi di interesse nominali vicini al limite minimo di zero, e un revival della letteratura su interrelazione fra politica monetaria e fiscale.
I risultati ci dicono molto. Semplificando al massimo:

- la deflazione si combatte generando domanda aggregata e aspettative di futura inflazione;
- in tempi di tassi di interesse a zero, la politica fiscale è meglio equipaggiata di quella monetaria. (1)

È ovvio che la politica fiscale può produrre un aumento diretto di domanda, ma può anche generare aspettative d’inflazione tramite una promessa di aumento delle future tasse sul consumo.
Come scrivono Francesco Giavazzi e Guido Tabellini, una politica di quantitative easing da sola non può funzionare, perché non garantisce che la massa monetaria raggiunga l’economia reale tramite credito e si trasformi in domanda aggregata. Anche l’acquisto di Abs, da solo, non può risolvere il problema.

COME VINCERE I TABÙ

L’Eurozona ha bisogno di un mix di politica economica straordinario per tempi straordinari.
Alla luce della letteratura economica, in una situazione di carenza di domanda e deflazione, è difficile contestare che nel breve periodo una politica fiscale espansiva finanziata con moneta generi crescita temporanea e inflazione.
Su un piano prettamente teorico, e tralasciando per il momento gli (importanti) aspetti politici, una politica di investimenti pubblici finanziata direttamente dalla Bce con moneta sarebbe a mio parere la strada preferibile:

- Il finanziamento con moneta non aumenterebbe il debito pubblico, vincolo imposto dai mercati, dal fiscal compact e sostenuto con forza da alcuni paesi del nord dell’Eurozona;
- Non comporta previsioni di maggiori tasse (o minore spese) future per ripagare l’aumento del debito, diminuendo l’effetto sulla domanda;
- Investimenti pubblici in settori che stimolano la crescita come infrastrutture, educazione e ricerca si trasformano direttamente in domanda aggregata e possono avere effetti positivi di lungo periodo. (2) Si tratterebbe di ampliare il piano Junker finanziandolo direttamente con moneta;
- Una diminuzione delle tasse (sul reddito o sulle imprese), invece non è detto che si traduca in maggiori consumi o in maggiori investimenti in momenti in cui questi agenti sono ancora afflitti da overhang di debito oppure in clima di elevata incertezza. Inoltre, se crediamo sia necessario agire con urgenza in modo coordinato a livello Europeo, potrebbe essere più veloce finanziare cantieri e progetti messi nel cassetto per mancanza di fondi.
- Risultati teorici ed evidenza ci dicono che il moltiplicatore della spesa sia maggiore di quello delle tasse, soprattutto vicino al limite di zero del tasso d’interesse o in recessione. È vero che in paesi ad elevato tasso di corruzione, esiste il pericolo di forte inefficienza. Si potrebbe creare una entità Europea temporanea che controlli e monitori direttamente l’implementazione degli investimenti.
- L’aumento di massa monetaria genera aspettative d’inflazione e la monetizzazione dovrebbe limitare la minimo gli effetti negativi sull’investimento privato. Anzi una manovra così radicale potrebbe determinare un “cambiare verso” delle aspettative.
- Monetizzazione da parte della Bce o finanziamento diretto del debito senza sterilizzazione non hanno differenza sostanziale, se la banca centrale detiene i titoli a scadenza. (3)

Non risolve i problemi di medio periodo

Queste politiche sono fatte per rispondere alla situazione congiunturale, e non risolvono i problemi strutturali che necessitano riforme profonde per dare competitività ad economie come Francia e Italia, per esempio, e quindi renderle capaci di generare crescita duratura nel medio periodo. Queste riforme nel breve potrebbero essere controproducenti per la deflazione (4) e necessitano tempi lunghi per produrre i propri effetti. Non risolverebbero il problema di breve periodo, ma sono fondamentali per non rendere vano questo sforzo. Da qui la necessità di legare il finanziamento monetario degli investimenti pubblici nei singoli paesi a concreti passi in avanti sulle riforme strutturali. Insomma la Bce paga moneta solo se vede cammello.

L’INDIPENDENZA BANCA CENTRALE E LA MONETIZZAZIONE

L’articolo 123 del Trattato vieta alla Bce di finanziare direttamente il debito pubblico (proposta Giavazzi-Tabellini) e tanto meno di finanziare direttamente stampando moneta.
La Bce ha un obiettivo chiaro, il 2 per cento d’inflazione, e lo sta mancando da troppo tempo. Se ci fosse un contratto, sarebbe inadempiente. Uscendo dal testo scritto del suo intervento, a Jackson Hole, Mario Draghi ha detto che la Bce è pronta a usare qualsiasi strumento per raggiungere la stabilità dei prezzi. Quest’affermazione prelude a un secondo “whatever it takes”? Si potrebbe riproporre lo stesso argomento usato per giustificare l’Omt: dato l’obiettivo, la Banca centrale dovrebbe avere indipendenza sulla scelta dello strumento migliore per perseguirlo, anche se lo strumento ha implicazioni “fiscali”. L’articolo 123 è stato aggirato già con l’Omt, acquistando titoli sul mercato secondario e mettendo quindi un piede nella politica fiscale dei paesi dell’Eurozona. Si tratterebbe ora di entrare a piedi uniti.
Peraltro, forse paradossalmente, il Trattato non mi pare vieti alla Bce né di investire direttamente, né di finanziare i privati, via “helicopter drop” o anche mediante linee di finanziamento dirette.
È del tutto ovvio come, politicamente, questa proposta sarebbe difficilmente accettabile in Europa.
L’Eurozona è malata. Molti paesi, come l’Italia, non possono permettersi altri trimestri di recessione-deflazione. Uscire da questa situazione è una priorità assoluta, bisogna essere creativi e andare al di là di clausole di Trattati pensati per altri momenti storici.
È il momento di rilanciare il “whatever it takes”, se non si vuole lasciare l’Europa alla mercé dei partiti euroscettici, che a quel punto avrebbero un argomento forte: l’inazione dell’Europa di fronte alla crisi.

(1) Per esempio, Correia, I., Farhi E., Nicolini J.P, and Pedro Teles. 2013, “Unconventional Fiscal Policy at the Zero Bound”, American Economic Review, 103(4): 1172-1211, Eggerston, G. and N. R. Mehrotra, 2014, “A Model of Secular Stagnation”, mimeo, Brown University.
(2) Si veda per esempio il recente contributo di M. Fratzscher sul Financial Times, che suggerisce di aumentare gli investimenti tedeschi in questi settori.
(3) È ovvio come nel caso della Bce, che sovraintende una zona euro a 18 paesi, le cose siano un po’ più complicate, ma lo sostanza è questa. Si noti inoltre che questo accade già con il quantitative easing (Ascari in lavoce.info sul carteggio fra il Cancelliere dello Scacchiere e il governatore della Bank of England).
(4)Eggertsson, G., Ferrero, A. and A. Raffo, 2014, “Can structural reforms help Europe?”, Journal of Monetary Economics, 61, 2-22.

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Draghi’s War on Savers and the Euro

by Pater Tenebrarum

ECB Cuts Rates From Nada to Zilch (and Less), Announces QE

In his Jackson Hole speech, Mario Draghi already hinted at further ECB interventions, pointing out that 5 year forward inflation breakevens indicated  that long term inflation expectations had fallen below 2% (i.e., 2% CPI rate of change). Consumers would of course see this as a reason to rejoice, but not our vaunted planners. It was already widely expected than an ABS purchase program would eventually be announced, as preparations for this have been underway for several  months.

Frankly, we thought that given that the TLTROs are beginning in September, the ECB would likely wait for their impact before announcing additional interventionist steps. As it turned out, they announced so many things at once on Thursday, they actually managed to surprise not only us, but apparently the great majority of market participants.

The announcement included: further rate cuts; with the repo rate now at 5 basis points, which we might as well call zero, this avenue is now rapidly closing. Since all rates were cut, they also increased the bizarre penalty rate on excess reserves to minus 20 basis points. All this measure achieves is that it costs the banks money. It's not going to make them more eager to lend, but it will lead to them cutting the paltry interest they pay to savers even further. So the war on savers is continuing at full blast.

As to these rate cuts, we would note that the central bank has been trying to “rescue” the economy with rate cuts for quite some time. It hasn't worked so far, but that is of course not stopping them from doing more of what hasn't worked.  This may be properly called “central planning insanity”. Even so, it is not clear to us why they believe another 10 basis points can possibly make a difference. Even if one erroneously thinks that economic growth can actually be spurred by monetary pumping, this appears to be an utterly futile gesture.

More surprising was that the ABS purchase program was announced concurrently, and along with it a covered bond purchase program. In his press conference Draghi promised a “substantial increase in the ECB's balance sheet”, which can actually be fairly easily achieved with this latter monetization initiative. Euro area covered bonds consist of two types, they are either backed by mortgage bonds, or by public sector debt securities (including agency debt). This is a big market, and there are very large covered bond programs out there, which can be used to add further to the already large supply of such bonds. Draghi pointed out that this will inject additional money directly into the economy.

Apparently the decision was not unanimous, and we can guess who the dissenters were (hint, the name of one of them starts with a “W”).

From experience we know that ECB refinancing operations do tend to lead to money supply growth acceleration in the short to medium term, and the combination of TLTROs and QE will surely have a noticeable effect with respect to that, unless the decline in private sector lending actually accelerates concurrently. For all the talk about “inflation being too low” (which is a totally absurd assertion anyway, since consumers can only benefit from the fact that prices are only rising slowly for a change), euro area-wide monetary inflation recently stood at 5.6% (narrow money supply). This is what we regard as the actual “inflation rate”.

Monetary inflation in the euro area. Note the y/y growth rate in blue. Thank God our central planners are able to implement such long term stability! – click to enlarge.

Bowing to Mercantilism

There has been a lot of yammering by various Mercantilists in Europe about the allegedly “too strong euro” (government minions in France are usually especially vocal about this). A strong euro benefits consumers and countless businesses that buy goods and services from abroad, while a weak euro is solely to the strictly temporary benefit of a small group of exporters. In other words, the idea is to help a small sector of the economy for a limited period, in exchange for hurting a much larger sector of the economy permanently. Brilliant.

Naturally, this is part for the course for our modern-day economic planners. They have evidently learned nothing in the past 450 or so years.  Why anyone would think it actually makes economic sense to weaken the euro is completely beyond us. Not a single nation on the planet has ever, in all of history, devalued itself to prosperity. The belief that this is possible is simply idiotic, not to put too fine a point to it. However, what can one conclude from the ECB's actions but that it wants to weaken the euro? Note here that Draghi has actually joined the chorus of complainers about the euro's strength around June already, so it appears he agrees that one can devalue oneself to prosperity. Anyway, it appears market participants were duly surprised by the announcement and decided to sell the already extremely oversold euro further. However, this move seems very long in the tooth by now, at least in the short term:

Note the gaps in this chart -  a break-away gap at the beginning of the move lower, and now there could be an exhaustion gap in evidence.  The euro has only twice been this oversold on a daily basis: when it crashed in the fall of 2008, and now – click to enlarge.

It should also be pointed out that speculators currently hold the second largest short position in euro futures in the currency's history. Amazingly, this 200,000 contract position (which is quite chunky in notional terms) is approaching the all time high net short position speculators held back in 2011/12, when the very survival of the euro appeared to be in doubt. The chart below shows the net long position of commercial hedgers, i.e., the obverse of the speculative net short position.

Speculation against the euro has become extreme.

The fact that the euro was in danger of breaking up a mere two years ago makes it especially strange that anyone in an official position would want to weaken it. Should they not be glad it has found willing buyers and holders again?

“Price Stability”

Lastly we want to briefly comment a bit more on the ECB's so-called “price stability” policy. First of all, this mandate implies that monetary inflation will go into overdrive every time the imaginary “general price level” isn't reflecting a devaluation of the currency's purchasing power by at least 2% per year. This naturally invites all the consequences a sharply rising money supply brings about.

While in the short term, an illusion of prosperity can be created, in reality real wealth will be redistributed, capital will be malinvested and increasingly consumed, and the economy will weaken on a structural level. It is not possible to lastingly increase society-wide prosperity by printing money.  Even if all the negative effects of monetary inflation did not exist, not one iota of real wealth could be brought into existence by printing more money.

However, what strikes us as especially irksome is that Draghi, similar to other monetary central planners, feigns concern with the unemployed and other victims of the last bubble the ECB aided and abetted with loose monetary policy. If they are all so concerned, then why are they deliberately taking steps that are aimed at debasing the currency?  When people struggle in difficult economic times, it seems especially important that their money should retain its exchange value. Making it worth less will only add to their troubles.

Such a policy can only be justified if one indeed assumes that money printing makes the economy “better”. In that case one not only needs to consciously reject sound monetary and economic theory, but must also cavalierly gloss over about 2,000 years of history, which show quite clearly that such policies have failed over and over again. Some of this history is fairly recent to boot.

Conclusion

After the last major inflationary push by the ECB (the LTROs of 2011/12), a brief surge in money supply growth triggered a temporary and evidently illusory spurt in economic activity. This Potemkin village quickly crumbled again, the very moment money supply growth declined back toward 5% y/y. The measures announced this Thursday may well achieve a similar Pyrrhic victory – but what then? Indeed, what Pyrrhus of Epirus is said to have remarked in the context of his victorious battles against the Romans can probably be applied in this context as well.

One only needs to adjust his saying a bit:

“If we are victorious in one more battle with the faltering recovery, we shall be utterly ruined”.

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Total Capitulation of the Bears

by Pater Tenebrarum

One of Wall Street's “Biggest Bears” Throws the Towel

Recently we have come across one of those forecasts that are a dime a dozen these days, and usually escape out attention. The article at Marketwatch, entitled “Bull could run 5 more years, carry S&P 500 close to 3,000” only seemed interesting because the forecast sounded a bit extreme. We quickly scanned the headline, thinking that whoever was making this assertion surely hadn't breathed a word about this when the SPX traded at just below 670 points in March of 2009. Such wildly bullish forecasts are strictly a function of SPX 2000 in our opinion, on a par with the “Dow 36,000” forecast, which gained some notoriety in the late 90s. One of the reasons behind the SPX 3000 forecast mentioned in the article did amuse us greatly though, namely the following:

“They cite extensive deleveraging in the U.S. as well as the uneven global recovery among other reasons why “this could prove to be the longest U.S. expansion – ever.”

Extensive deleveraging! Right.

“Extensive US deleveraging” in one comprehensive chart – click to enlarge.

However, in the meantime we have found out via Barry Ritholtz that the man making the prediction was hitherto apparently “one of Wall Street's biggest bears”:

“Until not so long ago, Morgan Stanley’s Adam Parker was one of the most bearish analysts on the street. […]

Following last year’s 30% S&P 500 rally, he has had a change of heart. He now has a 3000 upside target for the S&P 500.”

This background information actually does make the forecast a bit more interesting. It is yet another indication that bears have really capitulated across the board.

Recent Data – Yet Another Record Falls

In this context, take a look at the most recent Investor's Intelligence survey. Not only has the bull-bear ratio been at a 27 year high for two weeks in a row (i.e., a reading last seen in 1987),  but the percentage of bearish advisors has actually declined to a record low (as far as we know it was never lower) – only 13.3% of all advisors surveyed by II still declare themselves to be bearish:

The II survey exhibits the lowest bear percentage ever – click to enlarge.

This is of course in line with the other sentiment and positioning data we have frequently discussed in recent weeks, such as the extremes in the Rydex ratio (currently the Rydex bull/bear asset ratio stands at 17.75, i.e., it has surged back to a level close to the recently recorded record high of 18.51). Volatility and trading volume are both exceptionally low as well.

Interestingly, although margin debt has expanded again after its initial dip from the all-time high recorded earlier this year, it only managed to rise to a slightly lower high. This is an especially interesting divergence, as a roughly similar sequence has occurred near every major peak: first, margin debt expansion “goes parabolic”, then the total amount outstanding begins to dip a few months ahead of the peak in prices, and subsequently doesn't manage to make it back to its cyclical high. Interestingly, in spite of margin debt rising to a lower high, negative investor net worth is at a new record -  a sign that the cap-weighted indexes are masking internal weakness. This is of course confirmed by other technical data which we have recently discussed (see “Internals Are Weakening”).

NYSE margin debt bounces to a lower high after peaking earlier this year. Note the similarities between the last three parabolic advances in margin debt (chart via Doug Short) – click to enlarge.

Negative investor credit balances reach a new record in spite of the SPX reaching a new high and overall margin debt only rising to a lower high – this means that the average portfolio held by investors must be weaker than the cap-weighted indexes suggest – click to enlarge.

Finally, here is a long term chart of the NAAIM net fund manager exposure survey. What makes this data point interesting is that the recent pattern – i.e., the divergence of net exposure to prices – has been following a path that is by now beginning to look eerily similar to that of 2006-2007:

NAAIM survey of net fund manager exposure (replies ranging from “200% short” to “200% long” are possible). The divergence with the SPX is by now very similar to that seen in 2006/7 – click to enlarge.

Conclusion:

The so-called “wall of worry” is certainly no longer in evidence. Stock market bears seem to have given up entirely. Of course this capitulation has been a process rather than an event, and has been going on for some time now. Still, new records are seemingly made every month.

Fairly brisk money supply growth and extremely low rates have so far helped the market to recover from every correction attempt, with volatility contracting ever further in the process. Keep in mind though that even when both valuations and sentiment data are at or near extremes, it is still possible to get a blow-off move as a kind of last hurrah – this happened e.g. in late 1999/early 2000.

As to valuations, while the cap-weighted indexes appear still well below the peak valuations of the late 90s bubble, the same is not true of the average stock. While in the late 90s a handful of big cap tech stocks greatly distorted the total market P/E, a great many genuinely cheap stocks were available at the time (the entire “value” universe was quite subdued valuation-wise). This is definitely not the case this time around. It seems that both sentiment and valuations are at or near historical extremes. Investors may well be sitting on a powder keg.

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