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	<title>ECB &#8211; Alpha Strategy Consulting</title>
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		<title>Why the ECB should raise, not cut rates</title>
		<link>https://alphastrategyconsulting.com/why-the-ecb-should-raise-not-cut-rates/</link>
					<comments>https://alphastrategyconsulting.com/why-the-ecb-should-raise-not-cut-rates/#respond</comments>
		
		<dc:creator><![CDATA[Daniel Rodríguez]]></dc:creator>
		<pubDate>Mon, 09 Sep 2019 21:41:34 +0000</pubDate>
				<category><![CDATA[Finance & Markets]]></category>
		<category><![CDATA[Daniel Lacalle]]></category>
		<category><![CDATA[ECB]]></category>
		<category><![CDATA[Monetary Policy]]></category>
		<category><![CDATA[rates]]></category>
		<category><![CDATA[world economics]]></category>
		<guid isPermaLink="false">https://alphastrategyconsulting.com/?p=7025</guid>

					<description><![CDATA[&#160; &#160; Negative rates are likely one of the reasons behind the lacklustre European growth. Negative rates have worked as a tool to transfer wealth from savers to the indebted governments...]]></description>
										<content:encoded><![CDATA[<p><iframe width="1080" height="608" src="https://www.youtube.com/embed/XSeG3wy5lzg?feature=oembed" frameborder="0" allow="accelerometer; autoplay; encrypted-media; gyroscope; picture-in-picture" allowfullscreen></iframe></p>
<p>&nbsp;</p>
<p>&nbsp;</p>
<p>Negative rates are likely one of the reasons behind the <strong>lacklustre European growth</strong>. Negative rates have worked as a tool to transfer wealth from savers to the indebted governments that have abandoned all structural reforms, while these extremely low rates have also perpetuated overcapacity, incentivised the refinancing of zombie companies and effectively worked as a disguised subsidy on low productivity. Not only those measures have damaged banks, but they have also created very dangerous collateral impacts (read <a href="https://www.dlacalle.com/en/negative-rates-have-damaged-banks-but-that-is-not-the-worst-effect/">“Negative Rates Have Damaged Banks But This Is Not The Worst Effect”</a>).<span id="more-10041"></span></p>
<p>In recent weeks we have heard of a likely new stimulus plan that would include a new repurchase program and further rate cuts. A new asset purchase program is completely unnecessary and unlikely to spur growth when all Eurozone countries already have sovereign debt with negative yields in 2-year maturities and the vast majority have negative real or nominal yields in the 10-year bonds.  Why would the ECB repurchase corporate and sovereign bonds when the issuers are already financing themselves at the lowest rates in history?  Furthermore, by reading some statements one would believe that the ECB has stopped supporting the economy. Far from it, when it repurchases all debt maturities in its balance sheet and has implemented another liquidity injection TLTRO in March 2019.</p>
<p>The main problem of those who defend further purchases and more negative rates is one of diagnosis. The central planners believe the Eurozone problems come from lack of demand, and that investment and credit growth are not what they would want them to be only because investors and corporates believe that rates will ultimately rise, leading to defensive positioning.</p>
<p>The eurozone has seen nothing but demand-side stimuli, and after trillions of euros the economy is weakening because of them, not despite them. Because the problem is a supply-side problem that the ECB cannot solve. Rising interventionism and tax wedge that choke the private initiative despite alleged attractive conditions.</p>
<p>The other problem of diagnosis is to believe that credit growth and investment today are insufficient.  There is no evidence that companies are investing less than what they need or that citizens are not taking the credit they desire and are able to repay, rather the opposite. In fact, the rise of zombie companies that the BIS mentions in various papers is precisely a sign of malinvestment and excess capacity. Ultimately, the central planners who believe that credit and investment growth are insufficient think so because they ignore technology and aging of the population. When governments and central banks ignore the diminishing requirement of capital investment that technology creates and the changes in consumption and investment patterns from demographics, their diagnosis of what is adequate investment and consumption is simply wrong. Even worse, when the rationale to support the idea of “lack of investment” and therefore a need for lower rates is based on looking at 2001-2007 as “normal” years, they are always going to make a mistake. Those were years that no one should consider as average, but years of a bubble that burst badly.</p>
<p>A recent analysis made by Scope Ratings showed that “a tiered system of remunerating reserves to mitigate the impact of lower rates on bank profits will have a limited effect. Euro Area banks have already incurred EUR 23.2bn in charges since the negative-rate began policy in 2014, EUR 7.5bn in 2018 alone”. Scope calculates the annualized current running cost of excess liquidity is EUR 6.8bn. Any further cut to the deposit rate would cost EA banks EUR 1.7bn. “In other words, EA bank ROE is c.40bp lower than it would be in the absence of negative rates.</p>
<p>Why should the ECB raise rates by a small 25bps then?</p>
<ol>
<li>It would show a sign of normalization without any real impact on mortgage, credit or investment growth. It would be a signal of health.</li>
<li>It would stop the bleeding in banks, ultimately supporting the credit transmission mechanism, especially relevant in the eurozone, where banks finance 80% of the real economy.  Read this paper by Urbschat et al “<a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3338686">The Good, the Bad, and the Ugly: Impact of Negative Interest Rates and QE on the Profitability and Risk-Taking of 1600 German Banks</a>“. as well as Christensen et al “<a href="https://www.frbsf.org/economic-research/publications/economic-letter/2019/august/negative-interest-rates-inflation-expectations-japan/">Negative Rates and Inflation Expectations In Japan</a>“.</li>
<li>Negative interest rates are generating dangerous collateral incentives to take more risk in speculative areas, refinance zombie entities and drive investors to levels of excess risk that many find difficult to understand.Worth reading Palley’s  “<a href="https://www.elgaronline.com/view/journals/roke/7-2/roke.2019.02.03.xml">The fallacy of the natural rate of interest and zero lower bound economics: why negative interest rates may not remedy Keynesian unemployment</a>“, even if you disagree (as I do) with the idea of “demand shortage”. We have excess supply from demand-side policies, as well as “<a href="https://www.bis.org/publ/work793.pdf">Global Real Rates, A Secular Approach</a>” by the BIS.</li>
<li>Persisting with Japan-style measures, ignoring technology and demographics, as well as ignoring the side effects of negative rates will only lead the eurozone deeper into stagnation. The paper “<a href="https://www.nber.org/papers/w22177">Raise Rates to Raise Inflation? Neo-Fisherianism in the New Keynesian Model</a>” by  Garin et al also show that even if you follow the Keynesian principles of central planners, the best way to improve inflation expectations is to mildly raise rates.</li>
</ol>
<p>The evidence of the last years shows that<strong> the eurozone is slowing down</strong> in the middle of an unprecedented chain of fiscal and monetary stimuli. The failure to improve growth cannot be detached from the persistence on repeating failed measures. Implementing a larger quantitative easing and deeper rate cut program will not solve it,  because the diagnosis is incorrect.</p>
<p>A small rate hike added to support to those governments that implement structural reforms may help the eurozone. Monetary policy now is dangerously whitewashing populists who feel they can increase imbalances and put further fiscal strains on their countries’ budgets with no real risk, as yields continue to fall, albeit artificially.</p>
<p>A small rate hike would be a healthy signal that may help the ECB understand the real secondary demand for sovereigns, stop the zombification of the economy and improve liquidity transmissions to the real economy. Instead of being an incentive for reckless behavior from deficit-spending governments, it can be the beginning of an incentive to strengthen the private sector and the real economy.</p>
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		<title>The Fed’s Unnecessary Rate Cut</title>
		<link>https://alphastrategyconsulting.com/the-feds-unnecessary-rate-cut/</link>
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		<dc:creator><![CDATA[Daniel Rodríguez]]></dc:creator>
		<pubDate>Tue, 30 Jul 2019 21:55:44 +0000</pubDate>
				<category><![CDATA[Finance & Markets]]></category>
		<category><![CDATA[ECB]]></category>
		<category><![CDATA[FED]]></category>
		<category><![CDATA[Federal Reserve]]></category>
		<category><![CDATA[rate]]></category>
		<category><![CDATA[rate cut]]></category>
		<category><![CDATA[Trump]]></category>
		<guid isPermaLink="false">https://alphastrategyconsulting.com/?p=7009</guid>

					<description><![CDATA[If there is something that is evident is that the United States does not need a rate cut. With the economy growing at 2.1%, unemployment at 3.6%, creating 170,000 jobs per...]]></description>
										<content:encoded><![CDATA[<div class="tressis-subtitle">If there is something that is evident is that the <strong>United States does not need a rate cut</strong>.</div>
<p>With the economy growing at 2.1%, unemployment at 3.6%, creating 170,000 jobs per month, and estimated underlying core inflation of 2%, no objective data justifies cutting rates that are already artificially low. <span id="more-32249"></span>Wages are rising by 3% and credit growth for companies and families is solid.<span id="more-7009"></span></p>
<p>There is also no public sector financing problem. The 10-year US bond trades at a 2.05% yield, consistent with the country’s growth and inflation. In real terms, the United States borrows at almost no cost and without Federal Reserve support, as all bond demand comes from the secondary market.<span id="more-9867"></span></p>
<p>If the <strong>Federal Reserve</strong> cuts rates it can be for two reasons: One, because it expects a drastic and abrupt worsening of the economy, but that is apparently not the case, as the Fed itself talks of a “solid” economy. The second reason would be more concerning. The Federal Reserve would cut rates as a reactive measure against the monetary assault of the ECB (eurozone), the PBOC (China) and the BOJ (Japan). That is because it is recognizing in a veiled way that we are in a dangerous bubble inflated by central banks, and that we are heading for a currency war. It is no surprise that the dollar index (the DXY) has risen despite expectations of lower rates and even repurchase of bonds via reinvestment of interests in the United States. When all major economies “copy” the Fed without having the financial balance, economic dynamism and global reserve currency of the United States, they are basically implicitly saying “buy dollars”.</p>
<p>Constant easing has created major imbalances, from asset bubbles to rising zombie companies (<a href="https://www.bloomberg.com/news/articles/2019-07-29/asset-bubbles-to-zombie-companies-the-dark-side-of-rate-cuts" target="_blank" rel="noopener noreferrer">“Asset Bubbles to Zombie Companies: The Dark Side of Rate Cuts”)</a>.</p>
<p>In the eurozone, there is a similar case. There is no need to cut rates and launch another stimulus, which by the way has never been abandoned, by the way, since all expirations are repurchased). The excess liquidity in the ECB exceeds 1.79 billion euros, rates are already negative and the eurozone governments issue debt at negative and artificially low yields. The credit market shows the risk of dangerous bubbles when the spread between junk and high-quality bonds has fallen to historic lows.</p>
<p>The problem of stagnation of the eurozone and other economies has nothing to do with rates. Businesses and consumers are not going to take more credit or invest more due to a 0.5% change in already artificially depressed rates. The problem of stagnation in many economies is not due to lack of monetary stimulus but its excess. Zombie debt is perpetuated, overcapacity is maintained and malinvestment in high risk and low productivity sectors is encouraged.</p>
<p>The risk to markets is that investors fall again into the trap of betting on “the worse, the better”, that is, taking more risk despite the fact that the earnings’ season and macro data are disappointing, with traders betting it all on new liquidity injections.</p>
<p>The Fed and the ECB face the devil’s alternative. If they normalize monetary policy, they risk an abrupt and widespread correction in risky asset prices, and if they do not normalize, they lose tools to face a true cycle change. The Federal Reserve still has some tools, but the ECB is already in diminishing return territory in monetary policy.</p>
<p>The United States does not need a rate cut, but it probably will. Reducing exposure to the most cyclical part of portfolios may be a good idea because the race towards negative rates of the global economy has only one result: secular stagnation. Central banks will keep risky asset prices, but we cannot forget collateral damages. <span class="goog-text-highlight">When high productivity is fiscally penalized and monetary policy is rewarding the most inefficient and indebted parts of the economy, growth suffers and bubbles reach systemic size.</span></p>
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		<title>Lagarde, the ECB and the next crisis</title>
		<link>https://alphastrategyconsulting.com/lagarde-the-ecb-and-the-next-crisis/</link>
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		<dc:creator><![CDATA[Daniel Rodríguez]]></dc:creator>
		<pubDate>Mon, 15 Jul 2019 06:00:06 +0000</pubDate>
				<category><![CDATA[Finance & Markets]]></category>
		<category><![CDATA[banking system]]></category>
		<category><![CDATA[ECB]]></category>
		<category><![CDATA[EU]]></category>
		<category><![CDATA[European Union]]></category>
		<category><![CDATA[Largarde]]></category>
		<guid isPermaLink="false">https://alphastrategyconsulting.com/?p=7005</guid>

					<description><![CDATA[The appointment of Christine Lagarde as president of the ECB has been greeted with euphoria by financial markets. That reaction in itself should be a warning signal. When risky assets soar in the...]]></description>
										<content:encoded><![CDATA[<p id="paragraph_2"><span class="">The appointment of Christine Lagarde as president of the ECB has been greeted with euphoria by financial markets. </span>That reaction in itself <strong>should be a warning signal.</strong> <span class="goog-text-highlight">When risky assets soar in the middle of a huge bubble due to a central bank appointment, the supervising entity should be concerned.</span></p>
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<div id="SMIntext-clearfix-1562583834707" class="SMIntext-clearfix SMIntext-clearfix-4ef6a2d4-cee6-4304-9b31-dd979f74dadf desktop">Lagarde is a lawyer, not an economist, and a great professional, but the market probably interprets correctly is that the European Central Bank will become even more dovish. Lagarde, for example, is a strong <strong>advocate of negative rates</strong>.</div>
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<p><span id="more-7005"></span></p>
<p id="paragraph_4">Lagarde and Vice President De Guindos have warned of the need to carry out measures to avoid a possible financial crisis, proposing different mechanisms to mitigate the <em>shocks</em> created by excess risk. Both are right, but that search for mechanisms to work as shock buffers runs the risk of being sterile when it is the monetary policy that encourages excess. <span class="">When the central bank </span><em><span class="">solves</span></em><span class=""> a financial crisis by </span><strong><span class="">absorbing the excess risk</span></strong><span class=""> that the market once took it does not reduce it, it only disguises it. </span></p>
<p id="paragraph_5">Supervisors ignore <strong>the effect of risk accumulation</strong> because they perceive it as necessary collateral damage to the recovery. Risk accumulates precisely because it is encouraged.</p>
<p id="paragraph_6">Draghi said that monetary policy is not the correct instrument to deal with financial imbalances <em>and macroprudential tools should be used</em>. However, it is the monetary policy which is causing those imbalances when an extraordinary, conditional and limited measure becomes <strong>an eternal and unconditional one</strong>.</p>
<p id="paragraph_7">When monetary policy disguises and encourages risk, macroprudential measures are simply ineffective. There is no macroprudential measure that mitigates the risk created by negative rates and almost three trillion of asset purchases. More than half of European debt has negative returns and the ECB must maintain the repurchase of maturities, injections of liquidity and even announce a <strong>new program of</strong> quantitative <strong>easing </strong>in the face of the lack of sufficient demand in the secondary market for those negative yielding bonds. That is a bubble.</p>
<p id="paragraph_9"><strong>Risk builds up slowly</strong> and happens instantaneously. That is what the central planner does not seem to want to understand and the reason why <em>stress tests</em> and macroprudential measures fail in the midst of monetary stimuli. Because they start from a fallacious base: <em>Ceteris paribus</em> and that the already accumulated imbalances are <em>manageable.</em></p>
<p id="paragraph_12">When most Eurozone countries finance themselves at negative rates for up to seven to ten years, there is no reason to maintain current rates and stimuli.</p>
<p id="paragraph_13">The central planner can say that bond yields are low due to market demand, but when the Central Bank <strong>supplants the market by</strong> injecting, repurchasing maturities and announcing more monetary stimuli, the placebo effect in the real economy is imperceptible and the risk in financial assets is huge. The huge injection of money supply goes to other risk assets in search of a diminishing yield.</p>
<p id="paragraph_14">The eurozone has been in stagnation for several months, with <strong>many leading indicators worsening,</strong> and it is not due to lack of stimulus, but due to excess.</p>
<p id="paragraph_15">1.- 64% of the sovereign debt of the eurozone hs negative yields. <strong>Five trillion euros</strong> . Completely unjustified looking at solvency, liquidity or growth ratios.</p>
<p id="paragraph_16">2.- Junk bonds are at <strong>the lowest yield in thirty years</strong>, while the rating agencies warn that the solvency and liquidity ratios have not improved. The BIS warned of the increase of zombie companies, eternally refinanced at low rates despite not being able to cover their interest expenses with operating profit. Meanwhile, companies on the verge of bankruptcy are financed at rates of 3.5-4%.</p>
<p id="paragraph_17">3 .- The multiples paid for infrastructure assets have soared in little more than half a decade and now no one is surprised to see 19 times EBITDA paid for assets driven by low rates and cheap debt.</p>
<p id="paragraph_18">4.- Excess liquidity reached <strong>1.2 trillion euros</strong>. It has multiplied sevenfold since the launch of the repurchase program.</p>
<p id="paragraph_19">5.- The debt of non-financial companies in the eurozone remains <strong>above 78% of GDP</strong>, according to Standard and Poor’s, above the cycle maximum of the fourth quarter of 2008.</p>
<p id="paragraph_20">Many say that nothing has happened yet, although it is more than debatable, according to bankruptcies of financial entities and <strong>increase of zombie companies</strong>. However, the fact that there has not been a massive financial crisis yet does not mean that the bubble is not being inflated. And when that bubble is in several assets at once, there are no macroprudential measures to cover the risk.</p>
<p id="paragraph_21">The problem of central planners is one of diagnosis. They think that if credit does not grow as much as they think it should grow and investment and growth are not what they estimated, it is because more stimulus is needed. Many ignore <strong>the effect of overcapacity</strong>, excess debt and demographics while carrying out the greatest transfer of wealth from savers and the productive economy to the indebted.</p>
<p id="paragraph_22">Calls for prudence and <strong>risk analysis measures</strong> would be much more effective if misallocation of capital was not encouraged by the policy itself. We must be aware that lower rates and more liquidity will not improve the economy, but they may generate a dangerous <em>boomerang effect</em> on risk assets.</p>
<p>Lagarde faces two difficult options. On one side, continue with negative rates and liquidity injections which perpetuate overcapacity, make governments avoid structural reforms and stagnate the economy. On the other side, normalizing monetary policy would show the artificially low yields of sovereign debt as unsustainable.  She needs to face reality. The Eurozone does not need more monetary stimulus or government spending, it needs less interventionism.</p>
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