On Thursday, the ECB confirmed the end of net asset purchases and the timing leaves something to be desired.
In retrospect, Draghi probably should have started running a little faster down the road to normalization at the beginning of the year, when the eurozone economy was still robust. As documented pretty extensively on Thursday morning, economic activity is decelerating and that has some folks talking about “quantitative failure.”
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ECB Ends QE And, Critically, Enhances Forward Guidance Around Reinvestments
This raises a number of questions going forward, not the least of which is: What happens to spreads in countries were fiscal rectitude is on the way out the window thanks to the upsurge of populist sentiment? While Italy is the poster child for this, Emmanuel Macron’s efforts to placate the “Yellow Vest” protesters cast considerable doubt on the country’s fiscal position going forward. That’s starting to show up in markets.
(Bloomberg)
In the € corporate space, the end of CSPP comes at a particularly amusing juncture. As noted last week and as reiterated in the linked post above, € spreads are now right back to where they were before Draghi started buying.
“2019 will thus be the first year in many, in which markets will not have the calming influence of Mario Draghi’s buying working in the background and yet, Thursday was an ironic moment, in a way, for the ECB to close the book on such a profound policy”, BofAML’s Barnaby Martin writes, in a note dated Friday, adding that “credit markets have ’round-tripped’ during this extraordinary time, with high-grade spreads now back to March 16 levels — the time at which the ECB announced their foray into corporate debt buying.”
(BofAML)
Consistent with the failure of “buy the dip” in 2018 across both U.S. and European equity markets, high grade spreads have doubled across the pond since the February tights. For Martin, the question is what kind of credit “bear market” this will be.
“While the speed and severity of this sell-off is a far cry from the ’08 financial crisis, and also about half that of the periphery crisis, it nonetheless seems to be on par with the ‘01/’02 tech selloff and the ‘15/’16 China concerns”, he says, referencing the following set of visuals.
(BofAML)
A more poignant chart from Martin shows the number of 3+ standard deviation moves (wider) in the high grade market. “In big systemic risk periods — GFC, periphery crisis, China slowdown and (briefly) Italexit —more than half of the high grade market saw spreads widen by 3SD or more”, he writes, on the way to observing that, for now, “just 25% of the high-grade market has seen spreads widen by this amount.”
(BofAML)
What comes next? Well, Draghi attempted to calm concerns on Thursday by enhancing the forward guidance around reinvestments, but as BofAML notes, “for credit, this number is a paltry €6bn”.
(Bloomberg)
It will thus be left to the “stock” effect to keep spreads from widening materially. The ECB has absorbed around half of net supply and there’s some evidence to support the contention that the eligible universe has been a bit more resilient than the non-eligible universe this year.
(BofAML)
Still, there are questions as to how powerful the “stock” effect actually is versus the “flow” effect. After all, the latter represents an ongoing, price insensitive bid from a buyer armed with a printing press, while the former simply amounts to the assumption the sequestration of assets on the central bank’s balance sheet will preserve the supply/demand distortion and thereby support the market.
The question is where the marginal bid will come from and the problem for European credit in that regard can be summed up neatly with the following chart:
(Bloomberg)
When USD cash is yielding more than the broader global bond market, things tend to get messy for all manner of assets.
In any event, the bottom line for BofAML’s Martin is this (from the same cited note):
The fact that European credit markets are ending the year on a very fragile footing raises the chances, in our view, of Draghi having to dream up some credit-calming measures next year. We flagged in our year ahead the idea that the ECB could divert some redemptions from other programmes into CSPP in ‘19.
And speaking of “dreams”, when it comes to the fact that spreads are now back to wides seen before the inception of CSPP, Martin asks a simple question:
Nothing further.
QE has always been “quantitative failure”, from its conception. Any easing in financial conditions that it brought to the world was through expectations management (Draghi’s expertise, judging by his sycophantic fanboys). That is not to denounce its brilliance: the swap of toxic assets from bank’s balance sheets with non-toxic securities was a stroke of financial genius, because it sterilized the balance sheets of banks. But this portfolio sterilization never achieved its end goal, which was to rekindle the flow of credit in the real economy (as opposed to the financial economy) by allowing banks to swap their non-toxic CB securities for risky loans.
The real failure is central banks’ insistence on QE as the only acceptable measure to ease monetary conditions, something they never truly achieved (just looking at funding markets like the eurodollar market over the past 10 years is indicative of this). As a European I find it hard to sympathize with the gilets jaunes or the 5 Star Movement but their anger at technocrats’ incrementalism is the logical reaction to a lost decade for Europe’s non-asset-owning classes.