Christine Lagarde is concerned.
Specifically, she’s worried that without a coordinated policy response across Europe in the face of the COVID-19 outbreak and, now, an oil price war that shattered whatever was left of market sentiment, the world “will see a scenario that will remind many of us of the 2008 Great Financial Crisis”.
That’s according to a person familiar with comments the new ECB chief made on a conference call late Tuesday.
To be sure, she has reason to be concerned. Europe is on the front lines of the virus outbreak, the region’s economy arguably succumbed to Japanification years ago and the ECB’s armory is all but bare.
Recent “green shoots” notwithstanding, growth in Europe decelerated in Q4 which, colloquially speaking, was the worst quarter in seven years. That was before the virus came calling.
Markets are torn on what else the ECB can do. After all, September’s package (a rate cut, the restart of net asset purchases and tiering) was generally seen as pushing the limits already, and the decision to buy more assets was one of the most internally contentious moves of Mario Draghi’s tenure.
Now, Lagarde is faced with the unenviable task of doing more, with policy rates probably somewhere near the dreaded “reversal rate”, even as the bond market continues to push the issue.
As far as the balance sheet is concerned, it’s the same story. The ECB can always buy more assets – remember, many of the ostensible “limits” on PSPP and CSPP are self-imposed – but the question is whether the point of diminishing returns has been reached.
Europe has reached a point where, at various intervals, entire corporate yield curves have gone negative, which means that some corporate management teams can almost literally print assets. This is the “Twilight Zone” market discussed at length here on numerous occasions. If you’ve driven borrowing costs for corporates negative, what else can you reasonably do?
When it comes to equities, asset purchases just don’t matter at a time when a biological threat is seemingly spreading unchecked across the borderless bloc, prompting extreme measures like those adopted in Italy, where officials have locked down the entire country.
So, what to make of Lagarde’s lamentable situation? Well, analysts aren’t sure, but after Wednesday’s emergency BOE move, it’s probably safe to assume the ECB will attempt a similarly all-encompassing approach, pairing either a rate cut (or enhanced forward guidance) with targeted measures aimed at liquidity provision for the hardest-hit regions.
Unlike the BOE (and the Fed and the BOJ and on and on), the ECB is faced with coordinating monetary policy for a disparate set of economies operating under divergent political regimes, which complicates the crisis response. Lagarde has, for months, prodded the Germans to loosen the purse strings and on Wednesday, Angela Merkel promised to do “whatever is necessary” to combat the crisis.
And yet, countries with budget room remain recalcitrant. In a testament to just how absurd things have become when it comes to Berlin’s pathological obsession with fiscal rectitude, Bloomberg dryly notes that “the Irish government’s 3.1 billion-euro package to fight the spread of the coronavirus amounts to almost 630 euros per person — making it four times bigger than Germany’s measures announced through March 9 and 30 times bigger than those of the US, according to calculations by Goodbody Stockbrokers”.
Italy is angling to secure more budget room to expand its own stimulus to €16 billion and you can expect more from other countries, but the visual is simply meant to prove two points: 1) Germany really needs to stop it with the unhealthy obsession with “black zero” because at this point, it’s gone beyond absurd and into “laughable” territory, only “laughable” doesn’t quite work, because now, it’s not just the economy that’s dying, but people too, and 2) politicians are behind the curve.
“Only public sectors can break this ‘death loop’. While some investors believe that neither CBs nor fiscal authorities can do much, we continue to disagree”, Macquarie’s Viktor Shvets wrote Tuesday, adding that “public sectors can always alter direction of economies and markets, although often with significant side effects”.
Good luck, Christine – you’re gonna need it.