There was one central bank that did the opposite of what financial markets expected it to do, and it stirred up a mushroom cloud of anger: the Swiss National Bank removed the cap on the Swiss franc without warning. The franc soared, and the popular trade at the time – shorting the franc – blew up spectacularly. It ripped into leveraged FX trading accounts and FX brokers. And Swiss stocks dove.
But the ECB is not so inclined. It’s in a symbiotic and interdependent relationship with the financial markets. And so it gives them the goodies of their wildest dreams: QE and the new math of negative yields.
Negative yields have been spreading around Europe as the ECB has been hinting at a big bout of QE for two years. Hints have turned into a promise. But negative yields haven’t done anything for the economy. Instead, the ECB has instigated a currency war, where smaller non-euro countries around the Eurozone, on which they depend for trade, are desperately struggling to not get blown away by the swooning euro.
Negative yields are creeping into longer maturities of government debt in a number of Eurozone countries. Savers are increasingly getting hit with negative deposit rates. Negative yields have even started to crop up in European corporate bonds. And mortgages with negative interest rates have bubbled up in Denmark.
It’s all an experiment. The folks at the ECB have no clue how it will turn out. No one has ever done this before on this scale without end in sight, the absurd new math of paying someone – a government, a corporation, a homeowner – to take your money.
If these countries were stuck for the next many years in deflation of, say, 5% per year, it would make sense. But they’re not. For the Eurozone as a whole, there has been a slight dip into deflation caused by plunging energy prices – a good thing in countries that don’t produce energy. It lowers the cost of energy imports, cuts input costs for companies, and frees up money consumers can spend on other things. For countries that import their oil, falling oil prices are a godsend.
At what point are people going to stash crisp €500-notes – if they can still get them – under the mattress or in their walk-in closet, rather than paying a bank to hang on to their money, hoping that the bank won’t topple and take that moolah Cyprus-like with it?
What other distortions are caused when creditors are paying governments, corporations, and people to borrow money? What does it do to the creditors when a supposedly income-producing asset with some risk is churning out expenses instead? What damage will it do to the foundation of the economy?
The ECB doesn’t give a hoot about these issues. It has a different mission. And now we know from French investment bank Natixis, a subsidiary of Groupe BPCE, France’s second largest megabank, what that mission is.
The report agrees with most folks, if not nearly all folks, that the ECB’s QE will do “very little” for economic growth of the Eurozone.
The Eurozone had a record trade surplus with the rest of the world in 2014, and there is no trade imbalance to fix. The “wealth effect” has failed miserably in the US in cranking up the real economy; and it’s considered even weaker in the Eurozone. More liquidity for Eurozone banks? They’re already awash in it. Falling rates won’t boost lending. Rates have been falling for a long time, but there is not enough demand for loans. And triggering inflation? QE hands free money to well-connected speculators to drive up asset prices. But it’s unlikely to drive up consumer prices because consumers who could actually spend the money are not getting their hands on it.
But QE will have “significant effects on financial markets,” Natixis says. As that scenario plays out, with QE failing to produce economic growth, a new series of events will unfold. According to Natixis:
1. The ECB leaks the idea that it is considering further actions, in order to more effectively boost inflation and expected inflation. This is in fact already the case (as suggested recently by ECB Executive Board member Peter Praet).
2. Financial markets try to imagine what these further actions could be: an increase in the size of the quantitative easing program, ECB purchases of corporate bonds, bank loans, etc.
3. Having imagined them, financial markets factor in these further actions, leading to a tightening of credit spreads and a rise in share prices, especially for financial stocks.
4. Once these further ECB actions have been anticipated and priced in by financial markets, the ECB is forced to introduce them so as not to “disappoint” the financial markets, to prevent a market meltdown.
So Natixis tells investors that they should be thinking about the “after” – what “the next monetary stage” will be after the QE program kicks off in March and fails to produce results in the real economy. Just by thinking about it, and by beginning to expect this “next monetary stage,” investors will trigger it. These expectations are “self-fulfilling”:
If investors expect an action by the ECB, and financial markets accordingly factor in this action, then the ECB is practically forced to carry it out. There should therefore be serious thinking about the potential for even greater monetary expansion in the Eurozone.
The irony is that Natixis, one of the big beneficiaries of the ECB’s QE, is already getting the self-fulfilling prophecy rolling. It would be hilarious if it weren’t so serious how this works, how central banks are enslaved to the wishes of speculators and banks, and how any thought of acting independently from these wishes à la SNB is instantly stymied by the threat of a “market meltdown,” as Natixis put it – a situation that the little SNB had the guts to face, but that the big 800-pound ECB-gorilla can’t even imagine.