2016 has been the year that investors turned bearish on central banks.
Something snapped in the market’s collective psyche when Kuroda went NIRP and things haven’t been the same since. It’s as though everyone suddenly realized just how utterly insane this global monetary experiment has become.
In all likelihood, fiscal policymakers (i.e. elected officials) will also come to the conclusion that this has gone (way) too far - but not soon enough. Monetary authorities should have been reined in long ago, but they weren’t, and as a consequence, we are all guinea pigs in a global experiment that, if no one intervenes, is going to end with the abolition of physical banknotes and the possible imposition of deeply negative deposit rates.
Today we’ll get what may turn out to be the last gasp for previously unassailable central banks as Mario Draghi is widely expected to announce a flurry of easing measures including a further cut to the depo rate and both an extension and expansion of PSPP.
We documented how to trade the ECB announcement on Wednesday evening, but from a longer-term perspective, the record suggests equity markets are Fed up. “Mario Draghi is having no success convincing stock investors that the European Central Bank has the firepower to reignite growth,” Bloomberg notes. “In the first year of quantitative easing, the Euro Stoxx 50 Index fell 17 percent, and volatility reached levels not seen since 2008. The gauge has dropped in each month but one following an ECB meeting since April.”
As it turns out, “reality” trumps central bank fiction. Here’s the visual:
But that likely won't stop the ECB from "trying." This (hopefully) temporary descent into insanity still has a few more rounds to go. But Draghi will face his Waterloo on Thursday. There's no way he can exceed expectations. In order to "impress" markets, he would need to cut by at least 20 bps, expand PSPP by €20 billion per month, and extend QE by at least six months. That's a tall order, to say the least. Here's what economists think:
On top of that, Draghi will need to devise some manner of tiered deposit scheme if he cuts the depo rate further. Europe's banks are already under siege in the market and a further cut to the depo rate isn't going to do them any favors from a NIM perspective. The last thing the ECB needs is a swift sell-off in euro bank stocks. Here's a look at predictions for today's ECB announcement:
Expectations for today’s ECB meeting are high, but without consensus pic.twitter.com/7psqOvIciG
— Bond Vigilantes (@bondvigilantes) March 10, 2016
And here's WSJ's preview:
1. The rate decision
No rate cut would be a major disappointment for markets. Most analysts expect the ECB to cut the deposit rate by 10 basis points to take it further into negative territory, to minus 0.4%. The refinancing rate is expected to stay at 0.05%.
Negative interest rates have recently been sharply criticised for escalating a so-called global currency war, squeezing bank earnings and actually tightening credit conditions rather than improve them. Analysts at JP Morgan said in a note on Monday that negative interest rates overall have been counterproductive for equities, with eurozone, Swiss and Japanese stock markets all having fallen since they were introduced.
2. Two-tiered deposit system and/or cheap loans
Negative interest rates means banks have to effectively pay to hold cash on their balance sheets, while at the same time making less money on their loans. To mitigate the effect of yanking rates further into negative territory, the ECB is expected to introduce a two-tier deposit facility. This means some of the excess liquidity banks would deposit at the ECB will be placed at a rate above the deposit rate.
“This reduces the costs to the banking sector of a lower deposit rate and hence opens the way for additional deposit rate cuts.”Analysts at Danske Bank said in a note
Another possibility is for the ECB to offer banks generous long-term loans, such as the long-term refinancing operation (LTRO) introduced in 2012 and the targeted LTROs launched in 2014.
3. Changes to QE
One of the big disappointments at the December policy meeting was the absence of an expansion of the €60 billion-a-month asset-purchases program. This time around, analysts are again optimistic, speculating that the central bank will increase its QE purchases by €10 billion to €20 billion to take the monthly buys to as much as €80 billion.
Analysts at HSBC, however, said a QE expansion is unlikely this month, as the ECB still battles with technical constraints surrounding the program, such as simply finding enough bonds to buy.
4. New staff projections
The ECB will be in no shortage of reasons to act on Thursday. The updated staff projections are expected to be lowered significantly to reflect the weaker inflation and growth outlook that have resurfaced over the past months.
Holger Schmieding, chief economist at Berenberg, forecasts at least a 0.2 percentage point cut in 2016 growth projections to 1.5% and at least a 0.3 percentage point cut in 2016 inflation forecasts to 0.7%. The ECB has an inflation target of close to, but below, 2%.
5. Yet another disappointment?
The ECB destroyed a hoped-for Santa rally in stock markets in December, when its rate cut and QE extension massively disappointed investors.
With traders again seeming to bank on a substantial round of easing measures, several analysts have warned that we could see a repeat of the December carnage.
“Although we do believe that a larger cut or a drastic change in the QE-package is possible, we have to bear in mind that this week’s policy easing package is unlikely to be the last one and that the ECB will need to keep some measures on the back burner.”
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So Mario Draghi is staring down an impossible communication task. Grab the popcorn and stay tuned to see how he handles the pressure.
Out this morning from Goldman
In the wake of the December disappointment, the market is understandably asking whether the ECB has shifted towards incrementalism, with doves on the Governing Council – chief among them President Draghi – unable to push through more aggressive measures. We are in the camp that December was an unfortunate outlier and see three factors that could make today’s meeting a dovish surprise:
- More time to digest low inflation data: There was a dovish inflation surprise before the December meeting, with core HICP falling from 1.1 to 0.9 percent year-over-year in the advanced November reading. But that surprise came the day before, leaving little time for it to be incorporated into the debate on the Governing Council. This time around, core inflation fell from 1.0 to 0.7 percent year-over-year ten days ago. Although – much as in December – the latest reading comes too late to feed into the forecasts, there is more scope for this data point – which brings core inflation back to near its trough last year – to feature prominently in the discussion.
- No front-running by the President: Unlike the run-up to December, President Draghi has not been vocal in the run-up to today, with his last speech a relatively tame affair on Feb. 4 (there was also his testimony to the European Parliament on Feb. 15). This is in contrast to his speech on Nov. 20 in Frankfurt, where he said that inflation needs to be brought up quickly, signalling urgency for the upcoming meeting. We think the radio silence now signals a greater effort to build consensus for meaningful easing behind the scenes and avoid a repeat of the appearance of front running.
- No Fed hike around the corner: EUR/$ fell from 1.13 ahead of the Oct. 22 meeting to around 1.05 before the Dec. 3 meeting. Even among doves on the Governing Council, there may have been concern that – with Fed lift-off around the corner – EUR/$ could head through parity in fairly short order if the ECB added stimulus in a meaningful way. In other words, the ECB may have self-censored, basically out of “fear of floating.” With EUR/$ around 1.10 and little prospect of additional Fed tightening in the near term, such self-censorship may be less prominent this time around.
Our hope is that the ECB will surprise dovishly today, which should see EUR/$ go lower. A potential complication is if the ECB comes in close to consensus and then tries to surprise via credit easing. Such a scenario could see EUR/$ flat to slightly higher, given that the Euro strengthened during and after the June 2014 credit easing announcement, on speculation that portfolio inflows might pick up due to risk premium compression.