The ECB came into its first meeting of 2021 under the shadow of renewed lockdowns across Europe’s largest economies.
An aggressive second (or is this the third?) wave of the virus threatens to derail the central bank’s economic forecasts which were already subject to even more uncertainty than usual. And that’s just a nice way of saying that if forecasting is always impossible, it’s now just an exercise in abject futility.
The bank kept stimulus unchanged Thursday. Or, in the Governing Council’s words, “reconfirm[ed] its very accommodative monetary policy stance.”
Yields will stay where they are until “the inflation outlook robustly converge[s] to a level sufficiently close to, but below, 2% and such convergence has been consistently reflected in underlying inflation dynamics.” Purchases under the emergency QE facility will run “until at least the end of March 2022 and until [the ECB] judges the coronavirus crisis phase is over.” Principal payments from assets purchased under the program will be reinvested through 2023. “Regular” QE will continue at €20 billion per month.
In December, the central bank topped up its emergency pandemic QE program (PEPP), adding €500 billion in firepower to the facility, which serves as the cornerstone of Christine Lagarde’s crisis-fighting effort. A slim majority of Bloomberg poll respondents believe the ECB will ultimately end up using the entirety of the authorized firepower which, as of last month, is €1.85 trillion. “If favorable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full,” the new statement reads. “Equally, the envelope can be recalibrated if required to maintain favorable financing conditions to help counter the negative pandemic shock to the path of inflation.”
On the currency front, it’s the same story for the ECB. In fact, I can just recycle last month’s language verbatim, as it’s still wholly applicable. In addition to the effects from recent lockdowns across the bloc’s largest economies, a strong euro is another headache for Lagarde in her efforts to resurrect inflation, which plunged below zero on various pandemic effects that should start to fade, but not for another couple of months.
Earlier this month, Lagarde said the virus clearly “had a downward impact on price levels,” but suggested that “we shouldn’t write off inflation.” She also described the ECB’s projections for the bloc’s economy as “very clearly plausible.”
I suppose that depends on one’s definition of “plausible.” And also of “clearly.”
“What would be a concern [is] if after the end of March, member states need to continue having lockdown measures,” Lagarde added, in an online event convened by Reuters. The ECB is, of course, conducting a policy framework review, and investors are always keen to hear any details about how that’s progressing and where it might be going. According to unnamed officials who spoke to the media, the ECB has discussed the possibility of merging PEPP and APP (regular QE), as well as yield-curve control, as part of the review.
There was also some feigned incredulity (to use one of my favorite descriptive phrases) from market participants when Bloomberg stated what scarcely needed to be made explicit in an article out earlier this week.
“The ECB is buying bonds to limit the differences between yields for the strongest and weakest economies in the euro zone,” the article said, citing officials familiar with the matter, one of whom also indicated that “the central bank has specific ideas on what spreads are appropriate.”
While this makes for an amusing juxtaposition with Lagarde’s contention (made last year, prior to the pandemic) that it isn’t the ECB’s job to tamp down spreads and thereby ensure favorable borrowing costs for periphery governments, it’s not exactly like this is a secret. After all, the ECB has continually touted the “flexibility” of PEPP as the program’s most attractive feature. “Flexibility” just means the ECB’s capacity to deviate from the capital key when making purchases. That, in turn, just means targeting spreads. Here’s the language from the January statement, for example:
The purchases under the PEPP will be conducted to preserve favorable financing conditions over the pandemic period.
What do you reckon that means? “Financing conditions” couldn’t be any more “favorable” for the core.
“Investors have long wondered whether the central bank has specific levels in mind when it tries to cap bond yields,” Bloomberg went on to say, adding that “the latest insight into its strategy sheds light on how policy makers are navigating euro-area complexities that make publicly targeting bond levels difficult.”
The ECB’s task has always been a Herculean endeavor — it’s not easy to maintain a consistent monetary policy across disparate economies which, in some cases, harbor vastly divergent views around fiscal rectitude. This task is made immeasurably more difficult in an environment where populism is ascendant.
Rabobank’s Michael Every called spread targeting “a Rubicon-crossing monetary policy decision made with near-total opacity” and correctly noted that “market risk effectively ceases to exist [for periphery borrowers] as long as the ECB has your back.” To the extent this is, actually, a proper “policy,” there are myriad questions, some of which Every was happy to enumerate:
Who made this decision? On what authority? At what spread level? When will/can this be adjusted? And what if a Eurozone country elects a populist government adopting fiscal expansion? Would the ECB’s spread-targeting mechanism allow this? If so, or if not, more than one Rubicon is surely also being crossed.
Don’t expect any answers to those questions from Lagarde, assuming she even acknowledges the “scoop” from Bloomberg, whose Jana Randow and Jeannette Neumann noted that “the ECB’s strategy explains why the spread between Italian and German debt has stayed remarkably stable despite the Italian government nearing collapse.”
Of course, the Italian government is seemingly always “nearing collapse,” and with apologies to anyone reading from Italy (and while acknowledging that the US has no room to preach about political stability), if the ECB didn’t endeavor to cap Italian yields, there’s no telling what would happen after a decade of smothering price discovery for periphery debt. Here’s how I put it “Yen And The Art Of Bridge Maintenance“:
How much would you demand to loan Italy money until 2031? If your answer is a number far larger than 0.55%, then you can get an idea of what I mean when I say that allowing price discovery to reassert itself isn’t feasible.
And look, folks, these countries know this. Why do you think they’re terming out the debt?
The longer central banks are forced to shoulder the burden [of sustaining economies without fiscal support], the more dovish they have to be. That’s because the bubbles they’re being forced to inflate are taking assets so far away from what would otherwise be market clearing prices, that allowing the market to suddenly determine the price would lead to a simultaneous collapse across most of the fixed income universe, with God only knows what consequences for equities that are priced off record-low bond yields and quantitative risk models that were built and calibrated during an era of persistently suppressed volatility.
That’s the context. And it’s critical that everyone understands it.
Is it a desirable conjuncture? Well, no. But it’s not clear how to safely extricate ourselves from it. I doubt Lagarde has any ideas and if she did, she’d probably just roll out the Kuroda line, which Jerome Powell has recently adopted too: “Now is not the time to talk about an ‘exit’.”