Increase in yields makes more bonds eligible for ECB purchase
German two-, 30-year spread reaches most since Brexit vote
By disappointing bond investors this month, Mario Draghi has bought himself some time on quantitative easing.
The selloff since the European Central Bank president failed to signal an extension of the bond-buying plan on Sept. 8 has reduced the proportion of German sovereign debt yielding less than the institution’s deposit rate to 60 percent, from about two thirds in late August. Since the ECB is prohibited from buying securities below this threshold, the prospect of it running out of bonds to purchase has receded, data compiled by Bloomberg show.
The need for a tweak to QE has therefore become less urgent, Vincent Chaigneau, London-based global head of rates and foreign-exchange strategy at Societe Generale SA, said in a note.
When the euro region’s central banks are able to buy more shorter-dated bonds, because their yields are no longer below the ECB’s minus 0.4 percent deposit rate, then there’s less pressure for officials to purchase longer-term securities. This helped shorter debt outperform this week, steepening the German two- to 30-year so-called yield curve.
“It’s a nice side effect that yields are going up and it’s getting easier for the ECB to get all the bonds it needs, but it wasn’t their intention to talk yields up,” said Rene Albrecht, a rates and derivatives analyst at DZ Bank AG in Frankfurt. “Beyond a three-month horizon, yields should be biased for moving higher.”
The two- to 30-year yield spread widened to as much as 132 basis points, or 1.32 percentage points, this week, the most since the June 24 Brexit announcement. It was at 128 basis points as of the 5 p.m. London-time close on Friday.
Where bunds, and markets generally, go from here will be largely down to the Sept. 20-21 meetings of the Federal Reserve and Bank of Japan — particularly with the ECB’s next policy decision not due until Oct. 20.
Following the Frankfurt-based ECB’s last meeting, Draghi said officials would consider how to ensure its bond-purchase plan doesn’t run out of assets to buy.
Even with the slide since that gathering, German debt with maturities out to seven years yield less than the deposit rate. And with data Thursday showing euro-zone inflation remains well short of the ECB’s goal, for many investors, a QE extension is still a question of not if, but when.
* Economists predict extension of bond buying past March 2017
* Almost half of survey respondents expect ECB action this week
If at first you don’t succeed, extend, and then extend again.
With euro-area inflation stuck near zero for almost two years and Brexit now threatening to undercut the region’s recovery, economists see European Central Bank President Mario Draghi as highly likely to lengthen quantitative easing for a second time. That would take the asset-buying program beyond its current end-date of March 2017 and above the target of 1.7 trillion euros ($1.9 trillion).
More than 80 percent of economists in a Bloomberg survey expect such a decision, with a similar share predicting the ECB will tweak its purchasing rules to avoid running out of securities to buy. Almost half of respondents foresee action on Thursday, when the Governing Council sets policy in Frankfurt, with almost all the rest predicting an announcement at the October or December meetings.
Draghi’s position is reminiscent of the one Ben Bernanke faced in 2012 when the then-chair of the U.S. Federal Reserve added his third installment of asset purchases, so-called QE3, and promised to keep going as long as necessary. The ECB head has repeatedly said officials will keep up their stimulus until they see a sustained adjustment in the path of inflation, and the signs are that’ll take more than another six months.
“Conditions to withdraw monetary stimulus will likely not be met next March,” said Kristian Toedtmann, an economist at DekaBank in Frankfurt. “There is no point in postponing this decision.”
Inflation in the 19-nation euro area was 0.2 percent in August, unchanged from July, and core inflation weakened. Fresh ECB projections are scheduled to be released on Sept. 8., an event that has often underpinned a decision to change policy.
The more the ECB buys, the greater the risk that a scarcity of assets turns into a shortage. To avoid that, economists see it as almost inevitable that a QE extension would have to be accompanied by a change in the central bank’s self-imposed rules on purchases. That’s a potentially tricky debate in the Governing Council, which set the parameters to avoid concerns over market distortion, monetary financing and risk-sharing.
First among those tweaks would be to increase the maximum share of each bond issue that the ECB can buy, according to the survey. Second would be to drop the rule that assets are ineligible if they have a yield below the deposit rate, currently minus 0.4 percent. A minority says the central bank could move away from linking national QE allocations to the size of each economy, referred to as using the “capital key.”
“Removing the deposit-rate floor would be a powerful move and also politically less tricky than deviating from the capital key,” said Holger Sandte, chief European analyst at Nordea Markets in Copenhagen. “The ECB will have to change the QE parameters before long, but they will probably wait until December before taking some of the council members deeper into their discomfort zone.”
The great unknown in the ECB’s policy deliberations is the impact of the U.K.’s decision to leave the European Union. Despite grim predictions, there has so far been little observable negative impact on either the euro-area economy or Britain, its biggest trading partner.
The survey signals little in the way of revisions to the previous round of ECB economic projections, apart from the 2017 figure for gross domestic product growth. That estimate currently stands at 1.7 percent, and 37 of 50 economists said it would be cut.
The ECB’s current inflation forecast doesn’t see price growth returning to target before 2018. That means ending QE — economists expect a Fed-style tapering — is probably a long way off.
“My base case is that they will extend QE by six months in September,” said Claus Vistesen, chief euro-zone economist at Pantheon Macroeconomics Ltd. in Newcastle, England. “Anything else would be a disappointment, and likely cause a hiccup in markets.”
Mario Draghi may have bought himself a brief respite from the threat of deflation. The cost? More than a quarter of a trillion dollars.
On Thursday, the European Central Bank president should be able to deliver his first snippet of good news for a year on his mandate. Most economists in Bloomberg’s monthly survey predict the central bank’s forecasts for inflation and growth will be left unchanged or increased. Yet respondents see the relief as short-lived, with two thirds predicting more easing will eventually be needed.
The poll results underscore how the Governing Council’s meeting in Vienna, one of the occasional sessions held outside the ECB’s Frankfurt headquarters, is likely to mark a pause for officials after a fresh round of stimulus in March that included a bump of 240 billion euros ($267 billion) to their bond-buying program. While economists are skeptical the package will be enough to return inflation to the target of just under 2 percent, Vice President Vitor Constancio is more optimistic. He said last week that he believes consumer-price growth will be near that goal in two years time.
“The combined economics departments of the Eurosystem central banks must be sighing in relief over this round of forecasts,” said Anatoli Annenkov, an economist at Societe Generale in London. “They have a rare opportunity to forecast higher inflation.”
After ECB staff lowered their euro-area inflation projections in each of their last three quarterly forecasting rounds, just 9 percent of economists surveyed predict a cut for the 2016 and 2018 calculations at this week’s meeting. Eleven percent see a lower 2017 prediction.
The gathering in Austria takes place against a backdrop of growing concern among investors that central banks have run out of ways to bolster feeble prices. Before the meeting, fresh data should give officials more insight into how well the existing stimulus is working.
Eurostat will probably say on Tuesday that the inflation rate rose to minus 0.1 percent in May from minus 0.2 percent the previous month, and unemployment was unchanged at 10.2 percent in April, according to separate Bloomberg surveys. Brent crude, up more than 75 percent since January, is being closely watched for its impact on consumer prices.
The inflation rate in Germany, the region’s largest economy, unexpectedly climbed to zero in May, data showed on Monday. That’s above the median estimate for a reading of minus 0.1 percent in a Bloomberg survey of economists, and compares with minus 0.3 percent in April. A European Commission gauge of euro-area economic confidence rose for a second month to a four-month high.
That could all help lift the ECB’s previous projections, published in March, which foresaw inflation averaging 0.1 percent in 2016, 1.3 percent in 2017 and 1.6 percent in 2018.
Still, achieving the inflation goal any time soon remains a tall order. Core inflation, which the ECB says is a gauge for future price developments, slowed to 0.7 percent in April and is seen barely picking up to 0.8 percent in May. Euro-area negotiated wages rose a nominal 1.4 percent in the first quarter, the slowest pace since the inception of the single currency a decade and a half ago.
“We expect continued slow growth and weak core inflation to see the case for additional loosening build through the course of this year,” said Andrew Wishart, an economist at Capital Economics Ltd. “At April’s meeting, the Governing Council noted their concern over the divergence between still-low inflation expectations and rising oil prices, and a growing perception that monetary policy has reached its limit and can no longer boost growth.”
A key concern for the 25-member Governing Council is whether a failure to hit its inflation target for more than three years is undermining its credibility. Draghi will probably reaffirm the central bank’s commitment to take new measures if necessary, while stopping short of any new pledges for now.
The 67 percent of respondents to the survey who see more easing on the way is up from 61 percent in April’s survey. Just over half of those economists predict a fresh announcement at the Sept. 8 meeting.
The March decision saw quantitative easing increased to 80 billion euros a month from 60 billion euros, starting in April and running through March 2017. A further extension of asset purchases past that end-date is still seen as the most likely form of additional stimulus, though there are growing concerns that some countries will start to run out of eligible bonds. The ECB has said it sees no sign of shortages under current parameters for QE.
Among respondents who expect more easing, 84 percent said the ECB will buy assets for longer, down from 96 percent in April. Forty-two percent said the central bank will further cut its deposit rate, compared with 36 percent in the last survey. Just 16 percent said the central bank will expand QE above its current monthly target of 80 billion euros.
“The ECB is in wait-and-see mode,” said Alan McQuaid, chief economist at Merrion Capital Group Ltd. in Dublin. “Unless headline inflation and inflation expectations pick up over the summer months, then there is every chance we will see the ECB move again.”
Startling Inflation News Illustrates The Failure Of Easy Money
After three decades of epic deficit spending and three years of extraordinary money creation, Japan’s economy is enjoying a rollicking inflationary boom. Just kidding. Exactly the opposite is happening:
(Reuters) – Japanese households’ sentiment worsened in the three months to March and their expectations of inflation fell to levels before the Bank of Japan deployed its massive asset-buying programme three years ago, a central bank survey showed.
The survey’s bleaker outlook keeps alive expectations of additional monetary stimulus even as BOJ Governor Haruhiko Kuroda maintained his optimism that the world’s third-largest economy was recovering moderately.
Kuroda, however, warned that he was closely watching how a recent surge in the yen and slumping Tokyo stock prices could affect the outlook.
“Global financial markets remain unstable as investors are becoming increasingly risk averse due to uncertainty over the outlook of emerging and resource-exporting economies,” Kuroda said in a speech at an annual meeting of trust banks on Monday.
“The BOJ won’t hesitate to take additional easing steps if needed to achieve its inflation target,” he said.
The BOJ’s quarterly survey on people’s livelihood showed the ratio of households who expect prices to rise a year from now stood at 75.7 percent in March, down from 77.6 percent in December and the lowest level since March 2013.
A separate index measuring households’ confidence about the economy stood at minus 22.5 in March, worsening from minus 17.3 in December to the lowest level since March 2015.
The gloomy outcome underscores the dilemma the BOJ faces as it battles mounting external headwinds for the economy with its dwindling policy tool-kit.
The BOJ’s adoption of a massive asset-buying programme, dubbed “quantitative and qualitative easing,” in April 2013 was intended to spur public expectations that prices will rise, and in turn, encouraging households and firms to spend.
That has failed to materialise, forcing the central bank to add negative interest rates to QQE in January in a fresh attempt to accelerate inflation towards its ambitious 2 percent target.
The move has failed to arrest a worrying spike in the yen or boost business confidence. Japan’s economy contracted in October-December last year and analysts expect it to post only feeble growth, if any, in January-March. Inflation has also ground to a halt, keeping the BOJ under pressure to ease again in coming months.
A separate poll by private think tank Japan Center for Economic Research, among the most comprehensive surveys conducted on Japanese analysts, showed 39 of the 44 analysts surveyed projecting that the next BOJ move would be further monetary easing.
But Japan is a unique case; easy money is generating excellent growth and rising inflation pretty much everywhere else. Just kidding again. The US, after multiple QEs and a doubling of federal debt, is looking a lot like Japan:
U.S. consumers’ expectations for inflation declined in March following a rise from record lows the month before, according to Federal Reserve Bank of New York data released Monday.
The numbers, which have been highlighted recently as a potential cause for concern by top officials including Fed Chair Janet Yellen and New York Fed President William Dudley, may add to the debate over downside risks to the U.S. central bank’s 2 percent inflation target. These risks have contributed to policy makers’ cautious approach to tightening monetary policy this year following a decision in December to raise interest rates for the first time in almost a decade.
The median respondent to the New York Fed’s March Survey of Consumer Expectations expected inflation to be 2.5 percent three years from now, down from 2.6 percent in the February survey. In January, expected inflation three years ahead was 2.45 percent, marking the lowest level in data going back to June 2013.
The New York Fed divides survey respondents into two groups based on a short aptitude test: high-numeracy and low-numeracy. Expected inflation among high-numeracy respondents, which tends to be more stable than that for low-numeracy respondents, declined to a record low in March.
The drop came despite a rise in expected gasoline prices. The median survey respondent in March expected the cost of gas to be 7.3 percent higher a year.
Well, a data series from PriceStats (related to MIT’s Billion Prices project, I think) that measures a wide variety of prices in real time has the answer: Prices are actually falling faster than the official CPI number indicates, and have not picked up as oil has stabilized. In fact, the US has been in deflation for the past five months.
So it’s no surprise that people who are actually buying the stuff that’s falling in price would register this fact and answer surveys with deflationary sentiments. It’s also no surprise that central banks, which presumably see the same data, would be looking for ways to ease even further (Japan and Europe) or walk back their previous threats to tighten (the US Fed) — apparently in the hope that increasing the dose will cure the credit addiction.
This article is written by John Rubino of Dollarcollapse.com and with his kind permission, Gecko Research has been privileged to publish his work on our website. To find out more about Dollarcollapse.com, please visit:
Following the examples Finland, Canada and the Netherlands, the Japanese government is considering issuing money ‘vouchers’ to poor young people.
Tokyo plans to include gift certificates for low-income youngsters in the fiscal supplementary budget this year. The measure aims to halt a significant decline in consumption among the young.
The vouchers are considered to be more effective than cash handouts that could be deposited. People might use the coupons for their daily needs.
Consumption among young people is key to economic growth, according to the Japanese government. Recent surveys have shown that under 34-year old Japanese have cut spending by 11.7 percent year on year.
Japan is not the only country considering implementing the system known as ‘basic income’. Last November the Finnish social insurance institution proposed to allot a tax-free income of €800 per month. In various cities throughout the Netherlands people will receive an extra €1,100.
In February, authorities in Canada’s Ontario Province voiced plans to launch a pilot program of basic income later this year. Switzerland is due to hold a referendum on the issue this year.
Basic income was initially proposed in the 1960s and briefly tried out in the US and Canada. The idea has gained popularity in recent years as it could level income and wealth inequality.