FXstreet

To generalize the economic problems of Europe, focus on demand: the lack thereof. In essence, Europe is relying on the European Central Bank to add incremental growth but the logic of growth without demand is illusory at best. The ECB’s latest stimulus plans seem as impotent as previous programs such as the much maligned OMT. Add to this the fact that ECB Head, Mario Draghi, did not seem his hyper confident self at his last press conference where he announced the details of the Asset Backed Securities purchase program. Again, the ECB has demonstrated that after hand wringing and institutional-speed (molasses-like…) deliberations, the ECB will act. The question is whether anything the ECB does now is sufficient and whether monetary policy at all, can be counted on to spur economic growth rather than just financial asset price increases.

At this point of the Eurozone economic cycle, the bad news about ECB comes in two varieties: that whatever the new stimulus program, the magnitude will not be large enough; and/or, the real problems with the Eurozone are fiscal and political. The former is entirely negative because it may prove that final demand, in the current state of the Eurozone cannot be stimulated by monetary policy. The latter is self-evident and far harder to implement, solve or promote across disparate economies that are part of the EZ.

The ECB must know that investor realization of monetary sterility may, in and of itself, further clog transmission mechanisms and banish any existing animal spirits. That would logically decrease already weak Eurozone final demand. The also recently announced Targeted Long Term Refinancing Operation consisting of a total of $400 billion Euros to EZ banks at an interest rate of 0.15% (i.e., virtually free) was a notable failure in that only €82.6 billion has so far been requested. Remember, the “T” in the LTRO stands for “Targeted” and thus unlike the first LTRO versions this program requires EZ banks to on-lend this capital via loans to private companies. What a halcyon thought: that large companies and SME’s within the Eurozone would like to borrow money so they can expand their companies in order to make more money. The facts do not point to that demand quotient however. European companies are simply not applying for loans.

To illustrate the point, lending to businesses fell €1 billion in August from July event though M3 money supply was up 2% in the same period. As it relates to the Eurozone and these ECB efforts it is useful to keep the following in mind because of the potential for a continued and further divergence between real economy effects and asset prices:

• Banks are less likely to load up on new loans, even if credit risks are completely covered by TLTRO funds, prior to the completion of the ECB’s “Asset Quality Review” (“AQR”) of European banks. Surveys suggest that EZ banks are likely to draw on €175 billion of TLTRO funds in the December tranche. This rationalizes the idea that the AQR will act as a damper to higher acceptance of TLTRO by the banks until the AQR is completely over.
• Both of the TLTRO and the ABS programs show that the most powerful investment driver in the Eurozone continues to be the run up to an actual ECB announcement. That is, the old mantra of “buy the rumor, sell the news” seems to continue. Therefore, watch for what is next. Perhaps either excessive nervousness or relief over the AQR?
• The ECB’s goal is to stoke inflation back towards the acceptable 2.0% level. The relationship between private sector loan growth and inflation cannot be ignored. With private sector loans in the Eurozone contracting by 1.8% over the past two years, it is not clear how slowing the shrinkage of loans will equate to inflation. The more realistic reading of recent ECB efforts may be of stabilization rather than viewing them as growth propellants.

The other important issue to note as it relates to the ECB is that US market participants have taken some succor in idea that an aggressive ECB (and Bank of Japan) will act as a liquidity replacement for the Federal Reserve as they finalize the taper of quantitative easing and potentially raise interest rates. Some market participants believe that this outcome will result in further volatility and sales of US assets. With the volatility seen in credit markets over the past week, it is clear that any yield chasing in US assets by European investment managers may end violently though and have more to do with capital needs, politics and fiscal mismanagement than anything the ECB does.

Ultimately, the success or failure of the ECB’s ABS program and TLTRO will depend upon the amount of time given to these programs to succeed. This time component depends upon a multitude of factors some of which are admittedly vague because they are tied to political willpower. If the ECB has time to implement these programs to their fullest extent, it is reasonable to believe that improvement in the Eurozone will transpire over a long time horizon. In that case, it will nonetheless be uncertain whether ECB programs were a cause or effect of any economic healing, not asset price advances. One thing to remember is that when the first LTRO program was announced in December of 2011, it was widely viewed as a failure as it did not immediately boost demand nor stabilize asset prices. By late spring of 2012 however, it was clear that the LTRO was “working,” even if that work consisted (mostly) of banks buying their home country sovereign debt and parking excess reserves back at the ECB to earn riskless fees. No one ever said the ECB should get high marks for their frequent tardiness, in-fighting and marketing. On the other hand, the Portuguese bonds are no longer yielding 10.0%. Well, at least not yet as the confidence game continues to appeal to those on the right side of a one way trade.



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