Without QE, “Eurozone Financial Markets Would Collapse”

The euro dropped to $1.16, the lowest since 2005. The ECB has imposed negative deposit rates on Eurozone banks, which are passing them on to their depositors. The ECB will flog savers until their mood improves. It has flooded the Eurozone with liquidity whose excesses are sloshing audibly through the system.

Despite the Eurozone’s economic issues, stocks have soared in recent years. As have government bonds. The German 5-year yield is negative; the 10-year yield dropped to 0.41%. Forget France’s beleaguered government and economy, and the downgrades of its credit rating: its 10-year yield is 0.67%; its 2-year yield is negative. Spain’s 10-year yield dropped to 1.49% before edging up a little. Italy’s 10-year yield fell to 1.70%. These countries are borrowing at practically no cost.

Since 2011, the Eurozone’s current-account surpluses with the rest of the world have risen sharply, approaching 4% of nominal GDP, despite the debt crisis and even while the euro was very strong. The November trade surplus, reported today, jumped to €20 billion, up from €16.5 billion a year ago.

And it’s precisely this environment that the ECB wants to douse with even more liquidity by buying large quantities of government bonds to force interest rates down even further and devalue the euro even more. Because now it would suddenly heal the various problems each of the 19 Eurozone countries might have.

The decision will be announced after its meeting on January 22. It’s not like the ECB hasn’t tried similar things before. It already owns a ton of Greek debt that no one else wanted. It is already buying asset-backed securities and covered bonds. It has been lending banks essentially free money that they then use to buy government bonds. These machinations have been going on for years.

But under the new deal, the ECB would balloon its balance sheet to €3.1 trillion from €2.2 trillion by buying government bonds. It’s actually the old deal, lovingly dubbed Outright Monetary Transactions, announced in 2012 after Draghi’s “whatever it takes” pledge. But OMT ran into legal hurdles that remain unresolved. The ball is currently in the European Court of Justice before it bounces back to the German Constitutional Court. At issue: national sovereignty and the treaties that formed the EU.

But the word “deflation” has been thrown around with great passion to describe what amounts to mild inflation with the first tiny dip in years into deflation due to plunging energy prices. Core inflation remains positive. It’s just that folks in the Eurozone pay less to other countries for their fuel – which acts as a stimulant to the Eurozone economy.

“The risk of deflation is just a pretext for quantitative easing, for hammering out a bailout program for southern Europe,” Hans-Werner Sinn, head of Germany’s Ifo economic institute, told Bloomberg in his politically incorrect manner. The decline in inflation is due to lower crude prices, and “there’s no need for ECB action,” he said, pooh-poohing the entire concept.

Printing money to buy government bonds increases the risks for the Eurozone’s unity since it might violate the German Constitution, Sinn said. And Germany might be constitutionally bound to leave the Eurozone. “Somebody would have to give in, and that would be the ECB,” he said. “It would have to give up on OMT voluntarily.”

But financial powerhouses in Europe and on Wall Street have been clamoring for it, especially now that the Fed has stopped handing money to them. They want more, and the ECB will have to produce it.

The Royal Bank of Scotland, for example. Rather than increasing its €2.2-trillion balance sheet to €3.1 trillion, the ECB is planning to increase it to €4.5 trillion, RBS wrote in a paper fed to the media this week. This would amount to €2.3 trillion in additional QE, more than twice the amount ECB officials have bandied about.

Regardless of any legal challenges or opposition in Germany, “Large scale QE is coming imminently, on 22 January,” RBS said. “Waiting until March – something we have been asked many times – is just not feasible….”

The message: QE would cause bonds, stocks, and other assets to inflate further. So buy, buy, buy.

Now Natixis, the asset management and investment banking division of Groupe BPCE, the second largest bank in France – an institution that last July finally discovered the “Redistributive Effects” of QE – jumped into the debate.

QE would lead to “absurd financial asset prices,” its report said. Risk premiums would get squeezed further, interest rates would dive deeper into the negative. But the expectations of QE have already been baked into asset prices since markets “have been convinced since the summer of 2014” that “normal” QE would arrive by 2015. Hence, the devaluation of the euro, the plunge in long-term interest rates, and the evaporation of risk premiums.

This expectation by the markets, propagated by the big players, most recently by RBS, acts like a gun to the ECB’s head:

If the ECB announces today that it will not implement quantitative easing, Eurozone financial markets would collapse: rise in interest rates, fall in the stock market, and widening of credit spreads.

Accordingly, the ECB cannot refrain from implementing quantitative easing, since it definitely does not want financial markets to collapse.

But this situation could last: quantitative easing may be ineffective; the financial markets would then expect larger-scale quantitative easing (€1.5 trillion to €2.0 trillion), which would force the ECB to implement it.

The ECB is therefore a prisoner of financial markets’ expectations.

Instead of stimulating the economy, QE would boil down to a “disguised form” of monetization of government debt “to improve governments’ fiscal solvency.” And since interest paid by the government to the central bank is paid back to the government, it is “equivalent to a cancellation of the public debt bought by the central bank.”

QE would create “major tensions” with Germany. And it would “undoubtedly” drive some Eurozone countries “to take advantage of the monetization of their public debt to avoid reducing their fiscal deficits.”

Alas, since the financial markets are already baking this into prices, the ECB will have to follow through while dressing it up in nice verbiage. No central bank (even if it were so inclined) can stand up to what banks and big financial players are clamoring for, regardless of the ultimate costs to the economy, or society as a whole. They want more, they get more. It’s just that central banks might occasionally take turns in providing it.

In the US, where the Fed has ended what was once hyped as “QE Infinity,” ripples are already appearing. “We are not panicking,” said a bank CEO. Read…  How Wall Street Drove the Oil & Gas Drilling Boom That’s Turning into a Disaster

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  10 comments for “Without QE, “Eurozone Financial Markets Would Collapse”

  1. Jungle Jim
    Jan 15, 2015 at 3:01 pm

    It is of course blackmail, and as everyone knows, the worst mistake you can make with a blackmailer is to pay up. The only way to stop it is to call their bluff, but to make it clear that this time banks will be investigated vigorously and bankers held to account. The threat of serious jail time for the executives should encourage them to find other solutions. That may seem harsh, but eventually, the system will collapse of its own weight, and the longer we continue to knuckle under, the worse the final collapse will be when it inevitably comes.

    • GroundedMadness
      Jan 15, 2015 at 4:04 pm

      Nobody is clamoring for a scalp at SNB.

      • retired
        Jan 15, 2015 at 8:07 pm

        MR Madness,It just happened that the SNB is clamoring for a scalp.The scalp belongs to the EU & the Swiss are ending their francs value pegged to the Euro.The Swiss Franc’s value shot up 30% & the financial markets are going crazy!

        • Orlando
          Jan 17, 2015 at 3:18 pm

          Funny SNB should rescue the ECB’s QE program, right? Since 2011 the SNB has accumulated 500B of ECB bonds and NOW it ends the peg, sitting on a 25% loss, right?

          The EU can’t do QE, because it has to buy high rated bonds and only about 30% of the bonds fall in this category. In addition the union is limited by treaty to a 3% deficit or about 510B euros per year of available government debt. Multiply this by 30% high rated requirement and you have about 150B euros available. In addition, directs will be limited in the buy to about 25% or so, so only 40 billion euros can be bought in the open market via high rated government bonds without imploding the institution.

          Enter the SNB with 500 billion euros of bonds available for immediate purchase, terms subject to approval and you have the ‘best’ currency peg of all time.

          In one fell swoop, the Swiss get their peg, limit their losses and everyone goes home happy. Don’t think the CB’s had this planned out. The math says otherwise.

          Whether planned or not, the SNB HAD to end its’ QE, because the ECB does not have a monetary recourse.

  2. NotSoSure
    Jan 15, 2015 at 4:31 pm

    The smell of free money in the morning. So are we to see Euro parity with the US Dollar next month?

  3. runchummey
    Jan 15, 2015 at 7:07 pm

    Also anticipating the QE pronouncement along with Wolf was the Swiss National Bank.

    Today they announced that they will stop supporting the Euro (EUR)against the Swiss Franc (CHF). The SNB said they expected the ECB to implement QE for the financial gurus.

    This threw the markets into a tizzy and panicked the brokers on Wall street. Marketwatch was “shocked”:
    http://www.marketwatch.com/story/another-day-another-plunging-asset-2015-01-15
    and screamed that the SNB action would disrupt the markets.

    And disrupt it it has. The Swiss Franc currency ETF (FXF) jumped a whopping 17% in one day while the Euro ETF (FXE) dropped 1.6%. Stay tuned folks! The show has just begun…

    • Vespa P200E
      Jan 15, 2015 at 9:07 pm

      Is European monetary “union” experiment about to implode?

      Heard that there are bank runs in Greece and long forthcoming Euro exit might just happen back to drachmas and oh yeah default on debt obligations from other EU countries already with shakey balance sheet. Ditto for IMF (sorry Christine you cannot come and tell Greeks what to do) and ECB.

      But I sense our teflon stock market may not take a big hit, for now.

  4. Vespa P200E
    Jan 15, 2015 at 10:37 pm

    Good observations Wolf.

    It seems to me that the QE effects are diminishing evermore with additional rounds of QE. I think QE 1 was necessary and saved the market but geesh less bang for buck. Yet the market demands more. Kind a like junkie who demands stronger dose more often leading to code blue and often overdose death.

    Alas what if even the outright money printing and giving people money to spend to stimulate growth as who cares about some inflation in deflationary world until the STAGFLATION takes hold and inflation monster cannot be contained with riots on the streets everywhere? Far fetched – maybe but we’re certainly living in interesting times…

  5. LeftCoastIndependent
    Jan 16, 2015 at 9:57 am

    Wouldn’t it be a riot if Putin told Europe he wants to be paid in Swiss Francs for his energy exports.

  6. Jan 16, 2015 at 10:31 am

    Don’t panic!

    You aren’t rich enough!

    Wolf sez:

    “Despite the Eurozone’s economic issues, stocks have soared in recent years. As have government bonds … “

    This is without monetary easing, in fact excess reserves in eurozone are shrinking (as banks retire OMT loans as they come due). If stock markets have ‘priced in’ ECB monetary easing, they have done so with real money, without any help from the central bank.

    Stocks are jumping everywhere: China, Japan, US as well as Europe. Bankers don’t need help lending to each other, they need moral hazard in place when something goes wrong …

    Indeed … the message of the Swiss National Bank yesterday is that the Swiss public will no longer support tycoons’ vaporous ‘business interests’ … and this is a country that has made its own fortune by offering (swindling) services to these same tycoons! No wonder there is panic.

    Can other countries be far behind?

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