#TradingDebates — The end of easy money?
So markets worried about loss of liquidity have been looking around for the next source of easy money. And for a while they thought they had found it. Inflation in the Euro area is falling and some states – notably the Spanish giant – are in outright deflation. Surely the European Central Bank (ECB) must start doing QE?
Not a bit of it. The ECB does forward guidance like no other central bank. It will talk endlessly about being “ready” to do all manner of things, but actually doing them is an entirely different matter.
Chart: ECB liquidity
Liquidity in the Euro area continues to fall, and EONIA continues to rise as a result, putting upwards pressure on the Euro – but the ECB looks at its forecasts for Euro area growth (bound to rise some time soon) and inflation (will rise any time now) and sits on its hands. And with reason. Doing QE would be a political nightmare for the ECB.
The OMT program that backstops sovereign bond yields has never been used, and it is by no means clear that it could be: the German constitutional court has already ruled it unconstitutional in Germany, which means Germany could not fund that programme even if the European Court of Justice ruled it legal (which it probably will in due course). Sovereign bond purchases on a weighted-basket basis would have the unfortunate effect of creating synthetic Euro bonds, which would be anathema to Germany: but restricting purchases to AAA-rated bonds only would depress German bond yields possibly into negative territory, causing all manner of problems for investors.
But an even bigger problem for the ECB is the fact that unlike the US, most business finance is done through banks – and QE bypasses banks. ECB officials have suggested that they may do some kind of asset purchase program for securitised SME loans. But to be effective this would require considerable expansion of SME loan securitisations: at the moment there isn’t much of a market.
However you look at it, the ECB is not about to turn on the money taps. And nor are the other Western central banks: the UK is recovering, and neither Canada, Australia nor New Zealand are in sufficiently bad shape economically to justify QE, although there are some headwinds. Anyway, none of these is large enough to offset the loss of Fed liquidity. So where else could markets find liquidity?
There is always Japan, of course. The Bank of Japan continues to flood the place with money as part of the Abenomics program: whether this will be enough to lift the Japanese economy out of deflation is not yet clear. Inflation is rising, but this has not yet followed through into higher wages, and the new sales tax will have a disinflationary effect. The Bank of Japan seems set to expand its program of asset purchases and other measures to prevent deflation reappearing. Abenomics is only just getting going.
Chart source: Saxo Bank
But there is another possibility, too. I’m just waiting for markets to start applying the sort of pressure on China’s central bank, the PBOC, to do monetary easing that they have been applying (fruitlessly) to the ECB. China’s growth is slowing, inflation is falling and its banking system looks increasingly unstable: it does seem as if some form of monetary easing might be needed in the not-too-distant future to soften what could be a very hard landing. So far, PBOC, like the ECB, has sat on its hands, preferring to restrict liquidity in order to discipline the unruly Chinese shadow banks. But will it eventually be forced to turn on the spigot? It remains to be seen. The yuan is falling at the moment, which does not encourage monetary easing. But that could change.
The trouble is, of course, that yuan liquidity, although useful domestically, is not helpful to international players. Monetary easing in China might therefore take the form of UST sales to increase dollar liquidity. It’s not yet clear how the Fed would respond to this: if bond yields rose significantly, they might recommence asset purchases, but politically that would be problematic as it would amount to a subsidy from the Fed to China. It all goes to show how tangled the web of world finance has become.
But the bigger worry is about the future of markets that have become so dependent on continual infusions of central bank money. Will they ever recover from their addiction, or will they always be looking for the next fix?