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The New World Ordoliberalism Part 6: The QE Taper Caper and the Portuguese Squeeze

With 2017 set to be a year of critical elections for eurozone – including federal elections in Germany, the Netherlands, and France with the potential to reshape the eurozone – and since these elections are probably going to be heavily shaped by the ongoing existential freak out the eurozone’s wealthier nations’ role in the eurozone in relation to the seemingly endless eurozone crisis, 2017 is probably going to be an especially good year to point out that problems with the eurozone’s existing structure don’t include a problem with a eurozone disproportionately harming those wealthier members. The problem is quite the opposite: the eurozone is designed to help those wealthier members at the expense of its poorer fellow members.

And it’s set up to do this in a myriad of different ways, most obviously the systematic devaluation of the currencies of stronger economies coupled with the systematic increase in the currencies of weaker eurozone members. But, as we’ve seen with so many times of the “bailout” in the past, the “bailouts” themselves are also one of the many way the eurozone is designed, or evolved on the fly, to benefit the strong over the weak, often under the spirit of “no one member can benefit more than the others”. The eurozone is a strange construct if you haven’t noticed.

And in this particular chapter of our exploration of what’s wrong with the eurozone we’re going to take a look at the evolving nature of the European Central Bank’s (ECB’s) quantitative easing (QE) program. Specifically, how the QE program was facing a set of obstacles that was going to require some tweaking to the program and how the solution to the obstacle was to basically choose the tweaks that harmed the weak, in particular Portugal. In favor of Germany, of course. Keep in mind that Portugal recently formed a left-wing anti-austerity government and has done relatively economically well since coming into power . Also keep in mind that Portugal is one of the few eurozone nations not facing a rising far-right “populist” movement as a response to its harsh austerity program. So you might say the timing is “right” for some preferential treatment of Portugal. Preferentially bad treatment.

First, let’s take a look at the situation back in August, before these tweaks were put in place: The ECB was facing a QE conundrum. The QE rules state that the ECB can only buy eurozone government bonds under the following criteria (self-imposed criteria that the ECB created for itself earlier):
1. The total bond purchases for a given country can’t exceed 33 percent of its sovereign total bond market.

2. The bonds purchased cannot bear interest less than -0.4 percent.

3. Due to fears of QE becoming a backdoor bailout for the crisis-ridden countries, all bond purchases must follow a “capital key” that caps the maximum bonds that can be purchased in a given European country according to the size of that country’s financial system. In other words, all countries participating in the ECB’s QE program (all eurozone countries plus some others like the UK), would get equal stimulus, relative to the size of their economies and regardless of the need, or lack thereof, for the QE program.

Those were the rules. And by August, almost half the eurozone sovereign bond market was held by the ECB (no one said cleaning up a historic financial crisis would be quick or casual) and a significant problem was emerging: Germany was running out of bonds that were yielding above -0.4 percent. So if the QE program was going to continue without breaking the rules one or more of those three rules was going to have to be modified:

The Financial Times
Fast FT

ECB set to run out of bonds to buy – Credit Agricole

August 16, 2016

by: Mehreen Khan

Liquidity, liquidity everywhere and not a bond to drink.

In a world of record negative yielding sovereign bonds and ever-increasing doses of quantitative easing, the European Central Bank’s bond-buying blitz could soon hit the buffers.

The central bank’s €80bn-a-month debt spree will have hoovered up half the entire universe of eligible government debt by the end of the year, according to analysis from Credit Agricole, writes Mehreen Khan.

With the ECB scrambling around for paper, more than two-thirds of the sovereign bond market that qualifies for QE will be on the ECB’s balance sheet by next September they predict, leaving policymakers scratching their heads over how to extend stimulus measures.

And the scarcity problem is primarily German. According to its own QE criteria, the ECB is now excluded from buying Bunds with a maturity under seven years, as they have fallen below the -0.4 per cent yield floor set by the central bank. That’s around 40 per cent of the entire German bond market, or €413bn according to figures compiled by Tradeweb.

Germany matters. It is the largest economy in the eurozone and thus makes up the single biggest proportion of the capital key set out by the ECB for its total purchases.

“If the ECB cannot purchase German bonds, then it will have to change the modalities of its purchases”, says Louis Harreau at Credit Agricole.

“Germany’s share in the ECB’s capital is too big to be compensated by substitute purchases” he notes.

Analysts widely expect the central bank to tweak the terms of its stimulus programme to broaden the universe of eligible debt and ease the bond-supply bottleneck.

This can be done in three ways: by cutting the ECB’s deposit rate below -0.4 per cent; increasing the ceiling on its “issuer limit” from 33 per cent; and by shifting around with a “capital key”, where purchases correspond to a member states’ proportion of overall eurozone GDP.

Mario Draghi, ECB president, has promised “flexibility” to ensure the central bank continues to hits its monthly purchase target. But as ever in the eurozone, politics is set to throw sand in the wheels of any swift changes to the stimulus programme, which was first launched in March 2015.

Jens Weidmann, the uber-hawkish president of the Bundesbank and ECB board member, has cautioned against ramping up purchases from the indebted countries of the south as it would threaten the ECB’s cherished independence.

If “we focus more particularly on highly indebted countries, we blur the boundaries between monetary policy and fiscal policy which continues”, Mr Weidmann said earlier this month.

But removing political barriers to action would not prove a panacea if the ECB wants to keep the monetary taps on past a notional September 2017 end date, notes Mr Harreau.

He calculates that removing the deposit rate “will not be enough to alleviate the scarcity concerns” around German, Finnish, Dutch and Spanish bonds should QE continue after September 2017.

So what’s the best way to keep buying time?

The most effective option is also the boldest: dropping the capital key – where larger economies make up the biggest proportion of the monthly purchases. This would likely skew QE towards smaller economies, allow the ECB to continue snapping up bonds from Portugal and Ireland (former bailout countries), and “remove downward pressure on core yields”, adds Mr Louis.

But it’s also the option that will be most politically unpalatable for the larger northern creditor states of the eurozone.

All in all, the best solution to the ECB’s woes is one that would make the very necessity of QE pretty redundant – a growing economy, rising bond yields, and a natural increase in the universe of eligible debt.

Chicken and egg.

“The most effective option is also the boldest: dropping the capital key – where larger economies make up the biggest proportion of the monthly purchases. This would likely skew QE towards smaller economies, allow the ECB to continue snapping up bonds from Portugal and Ireland (former bailout countries), and “remove downward pressure on core yields”, adds Mr Louis.”

So back in August, it was clear something had to be done to allow the ECB’s QE program to proceed without running out of bonds. And it was also pretty clear to observers that the most effective way to tweak the rules would be to drop the “capital key” rule so the ECB can focus its bond purchases on the countries that need it most while avoiding the purchases of bonds in countries like Germany where bonds are already in negative territory. This was seen as the option that would be the most helpful for the eurozone as a whole, much more so than the other options like lowering the minimum “deposit rate” yield on the ECB’s purchased bonds below -0.40 percent which would simply allow the ECB to find more eligible German bonds (since so many of them are already yielding below -0.40 percent) to keep the QE program going.

Portugal (and Ireland) Approach the Limit and Preemptively Deviate From the Capital Key in Response

But also note that Germany wasn’t the only country running out of space to operate in the QE program, something that was obvious earlier in the year. As early as April, Portugal and Ireland were facing a different kind of problem and dropping the “capital key” wasn’t going to fix it. At least not alone. That’s because Ireland and Portugal were already on track to exceed the ECB’s 33 percent cap on the total volume of bonds held for a given nation before the QE program was set to expire in March of 2017 due to the fact that the ECB still has bonds from Portugal and Ireland leftover from its 2010-2012 “Securities Markets Programme” (the first of the eurozone crisis emergency responses). And as a result, the ECB’s QE bond purchases were already deviating from the “capital key” for Portugal and Ireland. And not in a helpful way:

Reuters

Wary of hitting limits, ECB holds back on Portuguese, Irish bond buys – sources

By Balazs Koranyi and John Geddie | FRANKFURT/LONDON
Tue May 17, 2016 | 9:20am BST

The ECB limited its sovereign debt buys of Portuguese and Irish bonds last month due to concerns about hitting its purchase caps, central banking sources said, in a move that could mean those countries stand to benefit less from the scheme.

With almost a year left of its quantitative easing programme, the ECB is already nearing a self-imposed limit of holding a third of the countries’ debt due to the large amounts of bonds it bought under previous crisis-fighting measures.

This became an issue when the ECB increased its monthly asset buys to 80 billion euros in April from 60 billion euros. Data shows that so far purchases have increased by more than 50 percent in most euro zone countries but only by 16 percent in Portugal and 33 percent in Ireland.

Two sources familiar with the situation said the ECB and national central banks that conduct the buying had supplemented Portuguese and Irish bonds with the debt of supranationals to avoid having to curtail buying of their debt more radically or even having to cut them off completely once it hits its limits.

The curtailed buying means that the ECB’s sovereign debt purchases will deviate slightly from the countries’ shareholding in the central bank, called the capital key, possibly muting the positive market impact of the scheme in Portugal and Ireland.

While QE has pushed borrowing costs in the euro zone to record lows in many countries, some investors say that uneven purchases of sovereign debt could mean vulnerable countries like Portugal do not benefit as much as the bloc’s largest economy, Germany, thereby escalating political tension in the region.

“If the ECB is going to target purchases on some sovereigns at the expense of other sovereigns, then effectively you have got an unequal application of that monetary policy,” said Mark Dowding, a portfolio manager at BlueBay Asset Management.

“In extremis, you are saying that this is going away from a trend where you are trying to bring Europe together, and it is looking more like something that could push Europe apart.”

LEFTOVERS

The sources said the ECB was keen to keep both countries in the programme until the projected end of the scheme in March 2017, but said that the buying could still fluctuate over time and that the ECB also reviews its issuer limit every six months.

Left over from its Securities Markets Programme, a scheme launched in 2010 to tackle an escalating debt crisis, the ECB held 9.7 billion euros of Irish debt at the start of 2016 while its Portuguese holdings stood at 12.4 billion euros. Since the start of QE, the ECB has bought 11 billion euros of Irish debt and 16.2 billion in Portugal.

The ECB’s issuer limit also suggests that if Greece joins the programme, ECB purchases will be severely curtailed as the bank is already one of the bigger holders of Greek debt.

The ECB has already stopped purchases in Cyprus because the country does not have the necessary credit rating and keeps sovereign buys limited in several countries, like Estonia, for liquidity reasons.

“This became an issue when the ECB increased its monthly asset buys to 80 billion euros in April from 60 billion euros. Data shows that so far purchases have increased by more than 50 percent in most euro zone countries but only by 16 percent in Portugal and 33 percent in Ireland.

That was the situation back in May, shortly after the ECB expanded its monthly QE bond purchases from 60 billion to 80 billion euros a month. Most of the eurozone countries saw a 50 percent increase in bond purchases but Ireland and Portugal, two of the countries that the QE program was intended to help, were forced to undershoot the increase relative to what the “capital key” would have called for.

But that was far from the only economic warning sign flashing for Portugal at the time. As the article below points out, Portugal is just one credit ratings downgrade away from getting kicked out of the ECB’s QE program entirely. And if that happens, Portugal will face a dilemma that’s now painfully familiar for the eurozone: leave, or undergo another round of “bailouts” (brutal austerity) with the hopes of reentering the QE program later:

The Wall Street Journal

Portugal’s Financial Independence Hangs by a Thread
Country’s access to ECB bond-buying program depends on debt rating by Canadian firm DBRS

By Patricia Kowsmann
April 29, 2016 12:30 a.m. ET

LISBON—Nearly two years after Portugal left a €78 billion ($88 billion) international bailout program, its financial independence continues to hang by a thread.

That thread is a little-known Canadian firm, DBRS Ltd., the only rating company that maintains an investment-grade rating on Portuguese debt. That rating gives Portugal access to the European Central Bank’s bond-buying program, which has kept bond yields low and relatively stable despite recent global market turmoil, a December bank failure and friction between European Union officials and the country’s new government over its budget plans.

On Friday, DBRS will announce the result of its twice-yearly review of Portugal. A downgrade to junk status—the rating the country gets from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings—would force it out of the ECB program and raise borrowing costs for its government, banks and companies.

That, in turn, could reawaken fears over Portugal’s future in the eurozone and the sustainability of the bloc itself, which is struggling to manage Greece’s fiscal troubles. Portugal would be required to take a new bailout to get a chance to re-enter the ECB program.

“The fact that the country’s future in sovereign debt markets hinges upon a single decision shows that Portugal is still in a very delicate situation,” said Antonio Barroso, an analyst at political-risk consultancy Teneo Intelligence. “It is also a reminder for politicians both in Lisbon and in Brussels that they should be doing more in order to prevent a return of the crisis to the eurozone.”

During its three-year bailout program, which ended in May 2014, Portugal was considered an exemplary follower of the Germany-led austerity model. The center-right government at the time, led by Prime Minister Pedro Passos Coelho, cut public employees’ wages, raised taxes and slashed spending to balance its accounts. The budget deficit fell sharply, from close to 10% of gross domestic product in 2010 to 3% of GDP last year, excluding a capital injection into a failed lender.

Mr. Passos Coelho privatized state companies and changed labor regulations to bring down labor costs and make exports more competitive.

Still, Portugal’s economy struggles. Exports are rising, but so are imports. Investments remain scarce. Unemployment exceeds 12%.

The International Monetary Fund predicted recently that Portugal’s economy would grow an average of 1.3% a year over the next six years, too slowly to reduce a debt burden that stands at 129% of GDP.

Portugal’s perception among investors has been hit by two bank failures since 2014 and the election of a Socialist-led government that has raised the minimum wage and promised to raise public-sector wages and lower taxes.

Socialist Prime Minister António Costa, who took office late last year with the backing of three far-left parties, has softened his rhetorical attack on his predecessor’s austerity measures. He has agreed to make deeper budget cuts this year to avoid a fight with the European Commission.

Even if it manages to avoid a downgrade now, pressure on Portugal is expected to grow.

DBRS has cited a global economic slowdown, debt sustainability and a rise in bond yields as factors to watch.

As he cuts the budget, Mr. Costa could be forced to choose between alienating his far-left allies in parliament or confronting the European Commission and its fiscal rules.

“The biggest concern that we would have would be [an] open conflict with the European Commission,” Fergus McCormick, head sovereign analyst at DBRS, said in February.

During its three-year bailout program, which ended in May 2014, Portugal was considered an exemplary follower of the Germany-led austerity model. The center-right government at the time, led by Prime Minister Pedro Passos Coelho, cut public employees’ wages, raised taxes and slashed spending to balance its accounts. The budget deficit fell sharply, from close to 10% of gross domestic product in 2010 to 3% of GDP last year, excluding a capital injection into a failed lender.”

And despite being considered an exemplary follower of Germany-led austerity, Portugal’s economy is still so fragile that a single credit rating downgrade could kick it out of the ECB’s QE program…a program designed to help the eurozone’s weakest economies. Isn’t the eurozone fun?

Fortunately for Portugal, DBRS – the last credit rating agency left in the world that gives Portugal’s debt an investment grade rating – did reaffirm Portugals credit rating back in April. And did so again in October. So, for now, Portugal is still able to participate in the QE program that is vital to its economic recovery. But just barely.

And as we saw above, there’s still the issue of less Portuguese bonds being bought under the QE program than the “capital key” warrants due to concerns over the country hitting that 33 percent cap before the QE program finally winds down. So even if ECB extends the QE program past its March 2017 deadline, the question of how Portugal would get around these barriers remained.

The ECB’s Disappointing September. And Terrifying Taper Talk in October

And what did the ECB eventually decide to do with Germany running out of eligible bonds and countries like Portugal and Ireland hitting their 33 percent cap? Well, also keep in mind that the current round of the ECB’s QE program is scheduled to expire in March of 2017. So with a number of eurozone economies still in dangerously fragile territory the expectation back in September was that, at a minimum, the ECB was going to announce an extension of its QE program past March 2017 during is meeting on September 8th. And, or course, that didn’t happen, despite a cut in the estimated economic growth forecast:

CNBC

ECB surprises by failing to extend QE deadline; cuts euro zone growth forecasts

Katy Barnato
Thursday, 8 Sep 2016 | 9:06 AM ET

The European Central Bank (ECB) surprised markets on Thursday by failing to extend the deadline for its trillion-euro bond-buying program.

Expectations were high the central bank would prolonging the program beyond its current deadline of March 2017, but it did not do so.

The euro zone STOXX 50 index fell on the news, but the euro rose slightly against the U.S. dollar to near a two-week high. The yields on German benchmark 10-year Bunds turned slightly less negative.

ECB President Mario Draghi said the central bank did not discuss extending the program at its latest monetary policy meeting.

“Our program is effective and we should focus on its implementation,” he said at his regular post-decision media conference on Thursday.

The ECB held its key interest rates unchanged on Thursday, as expected. The rate on the ECB’s marginal lending facility stands at 0.25 percent, with the rate on the deposit facility at -0.4 percent. The fixed rate on the ECB’s main refinancing operations remains at zero. The ECB last moved rates in March, when it cut the rate on the marginal lending facility by 5 basis points.

Despite the ECB’s monetary stimulus program – which includes low or negative rates, low-interest loans to banks and a trillion-euro bond-buying program – the euro zone’s economic growth and inflation rate remain stubbornly low.

On Thursday, the central bank raised its economic growth outlook for the euro zone slightly for 2016, but cut it for 2017 and 2018. It now sees growth in the 19-country bloc averaging 1.7 percent this year, having previously forecast 1.6 percent growth. It forecasts expansion of 1.6 percent in 2017 and 2018, down from its June forecast of 1.7 percent in both years.

The central bank’s 2016 inflation forecast was held at 0.2 percent and its 2018 estimate stayed at 1.6 percent. However, it cut its 2017 forecast to 1.2 percent from 1.3 percent.

“We will preserve the very substantial amount of monetary support that is embedded in our staff projections and that is necessary to secure a return to inflation,” Draghi said in his statement.

Draghi said the ECB’s monetary stimulus would boost euro zone economic growth by 0.6 percent over the forecast horizon and inflation by 0.4 percent.

The euro zone’s economy is seen being hampered by sluggish global demand, due to several factors, including the U.K.’s vote in June to quit the European Union, he added.

The ECB’s inflation forecasts are particularly important, as the central bank has a single mandate to target price stability. It aims for inflation of close to, but below 2 percent over the medium term. Average inflation in the bloc, based on non-harmonized national consumer price indexes fell below 1.75 percent in March 2013, kept on falling, and is currently around 0.2 percent.

Prior to Thursday’s announcement, there was speculation the ECB might extend the deadline on its quantitative easing program. The ECB has extended the deadline before, upped its monthly asset-purchases of securities to 80 billion euros ($90 billion) from 60 billion euros and expanded the program to include corporate bond-buying.

Focus has now shifted to whether the ECB will announce an extension to the program later this year.

“On Thursday, the central bank raised its economic growth outlook for the euro zone slightly for 2016, but cut it for 2017 and 2018. It now sees growth in the 19-country bloc averaging 1.7 percent this year, having previously forecast 1.6 percent growth. It forecasts expansion of 1.6 percent in 2017 and 2018, down from its June forecast of 1.7 percent in both years.”

After lowering its growth forecasts for 2017 and 2018 slightly, ECB’s response back in September to the question of whether or not it’s going to extend the QE program past March: The ECB wasn’t sure. Check back later in the year.

So that was the ECB’s position on the future of QE back in September. But by early October another message started emanating from ECB policy-making circles: If the ECB decides to discontinue the QE program, don’t expect those monthly ECB bond purchases to end suddenly. Instead, much like what the Federal Reserve did to eventually end its QE program, markets should expect the end of the ECB QE’s to come in the form of a “taper” where the monthly ECB bond purchases are steadily lowered to eventually zero. And while the idea of “tapering” the QE makes a lot of sense and isn’t all that notable, having anonymous leaks to the press that the ECB was thinking about “tapering” at a time when the eurozone economies are still very fragile and everyone is wonder if the QE is going to be extended at all was pretty notable. And alarming:

The Financial Times

Why eurozone bonds are rattled by taper talk

Germany’s 10-year Bund approaching a positive yield for the first time in two weeks

by: Elaine Moore
October 6, 2016

European bond markets are being rattled by talk that the European Central Bank is considering ways to call time on its €80bn-a-month bond-purchase programme before the March 2017 end date.

While the ECB has denied the reports, bonds across the eurozone are selling off — with Germany’s 10-year Bund yield on the cusp of turning positive for the first time in two weeks.

What’s rattling traders?

On Tuesday, Bloomberg published a story citing unnamed sources who claimed that the ECB was thinking of winding down its bond purchases in steps of €10bn a month ahead of its plans for QE to end in March, triggering an immediate jump in yields across bond markets.

The ECB is adamant that QE tapering is not up for discussion, with Michael Steen, head of media relations at the ECB, tweeting that the “governing council has not discussed these topics, as Draghi said at last press conference and during testimony at the European Parliament”.

Is this a taper tantrum?

Taper is not a word financial markets like to hear. Benchmark 10-year government bond yields of Germany, France, Italy and Spain all jumped about 4 basis points in the space of an hour and have continued to climb.

The moves illustrate how dependent investors have become on mass bond-buying programmes from central banks in Europe, the UK and Japan — but so far this sell-off does not compare with the “taper tantrum” triggered in 2013 by the US Federal Reserve plans to slow down its QE purchases.

Yields on Germany’s 10-year Bund — a proxy for wider European markets — are up a few basis points not percentage points and remain far lower on the year.

What do investors think?

Bond strategists and fund managers seem torn between suspicion that there is no smoke without fire and conviction that with eurozone inflation still low, any talk of tapering seems premature.

JPMorgan notes that views attributed to anonymous “sources” should be viewed with caution, noting that ending QE and raising interest rates would be difficult with inflation at current rates.

In fact, falling bond yields in recent months suggest investors had been expecting the ECB to relax its self-imposed limits and expand the universe of assets it can buy in order to address scarcity in the eurozone government bonds eligible for QE.

Frederik Ducrozet at Pictet has another idea. Perhaps, he says, conversations about tapering are being used to soften up ECB governing council members who oppose an extension of the programme — such as Jens Weidmann, head of the Bundesbank.

“The leaks could also be a superficial concession to the hawks ahead of a decision to extend QE,” he says. “A way to reassure them that an exit plan for QE exists, even if it is enlarged in the short term.”

What will happen next?

The next meeting of the ECB’s governing council is on October 27 but policymakers are not expected to make a decision on QE until later in the year, after the inflation forecast for 2019 is published. If inflation looks as though it will continue to undershoot then the case for QE extension will be stronger.

Andrew Bosomworth, Pimco’s head of portfolio management in Germany, says QE must end at some point, but points out that it will be a delicate balancing act.

“It will be difficult for the ECB to stop QE without there being an impact on bond yields,” he says. “And the ECB has to be careful to navigate the exit in such a way that yields do not rise to such levels that indebted countries have difficulty — something that could reignite the threat of another eurozone sovereign debt crisis.”

“Bond strategists and fund managers seem torn between suspicion that there is no smoke without fire and conviction that with eurozone inflation still low, any talk of tapering seems premature.”

Yeah, it’s hard to see why talk of a how the ECB might “taper” the QE program wouldn’t spook the markets. But the reason such talk would spook the markets – the reason being that the eurozone economies are still dangerously fragile and ending QE prematurely could be a disaster – also happens to be the reason such talk is hard to interpet. Because tapering the QE makes absolutely no sense in the current context. And yet such talk did reportedly take place, at least according to anonymous sources, although the ECB denied the reports.

The ECB’s Less Than Enthusiastic Response to Trump in November

So what did the ECB finally decide to do about the future of the QE program during its December 8th meeting? Well, before we get to that, note that there was another rather significant event that took place recently that would also reasonably impact the ECB’s decision-making regarding the future of QE: the election of Donald Trump. And based on the comments coming from the ECB officials in the weeks following Trump’s win, despite the expectations of rising inflation and the talk of a new US fiscal stimulus program, the ECB officials didn’t appear to see a Trump administration as likely helpful for the eurozone. And possibly very unhelpful:

Reuters

ECB fears populist backlash after Trump’s win: sources

By Francesco Canepa and Balazs Koranyi | FRANKFURT
Fri Nov 18, 2016 | 10:13am EST

European Central Bank officials are growing increasingly worried that Donald Trump’s victory in the U.S. presidential race may harm the euro zone by hurting trade with the United States and fuelling populism.

Speaking publicly and behind the scenes, ECB officials emphasise any U.S. shift towards protectionism under Trump could hurt the already fragile euro zone economy and pave the way for an even stronger backlash against globalisation and the euro project.

This could hinder the ECB’s efforts to revive growth and inflation in the euro zone just as the economic picture was starting to look less bleak.

If they only looked at financial markets, ECB rate setters should be moderately pleased: euro zone inflation expectations, bond yields and stocks have all gone up since Trump’s victory, showing investors are betting on spending-led stronger U.S. economic growth.

In addition, higher bond yields have eased immediate concerns the ECB may run out of German debt to buy in its 1.74 trillion euros asset-purchase programme, the centre-piece of its stimulus strategy.

However, top officials stress the situation is far more complex than this and the ECB still looks still set to announce an extension of its bond buying beyond their March deadline at the bank’s Dec. 8 meeting.

First, rising borrowing costs for indebted peripheral governments show that investors are pricing in rising political risk in the euro zone as anti-globalisation and eurosceptic voices are emboldened by Trump’s win, which came hard on the heels of the Brexit vote.

This was particularly visible in Italy where the government’s borrowing costs were on track on Friday for their biggest two-week rise since the 2012 debt crisis and banking stocks fell ahead of a Dec. 4 referendum that could unseat pro-euro Prime Minister Matteo Renzi.

“The overall (market) signal is not clear cut,” a central bank official said, stressing it was still too early to consider any countermove.

Second, Vice President Vitor Constancio has warned that any fiscal easing in the United States — such as Trump’s planned infrastructure spending — may not benefit the euro zone if the new U.S. administration sticks to its ‘America first’ pledge, hurting Europe’s exports to its biggest trading partner.

Even a hawkish member of the ECB’s Executive Board, Yves Mersch, warned that growth in the euro zone was still “fragile” and the inflation pick-up not yet sustainable.

This was further emphasised by President Mario Draghi, who said on Friday the recovery relied on continued monetary support from the ECB.

Both Mersch and Draghi also warned that rolling back financial regulation could pave the way for a repeat of the 2008 crisis, a thinly veiled reference to Trump’s campaign promise to ease those rules.

Meanwhile, confidence remains low that euro zone governments will heed the ECB’s long-standing call for greater fiscal spending in surplus countries such as Germany, despite a European Commission’s plea for looser strings this week.

“In principle, we welcome any proposal for growth supportive fiscal policy,” Mersch told Reuters this week. “But we have not seen the details and there have been some disappointments in this regard in the past.”

“Speaking publicly and behind the scenes, ECB officials emphasise any U.S. shift towards protectionism under Trump could hurt the already fragile euro zone economy and pave the way for an even stronger backlash against globalisation and the euro project.”

Well, that certainly sounds like a Trump victory would make the ECB more, not less, likely to announce an extension of the extend the QE during its December 8th meeting. And given that rising bond yields in response to Trump’s victory increased the number of German bonds above -0.4 percent, more bonds will be available for the ECB to purchase and, one might assume, the ECB would be less likely to pursue the option of lowering the minimum bond yield the ECB can purchase below that -0.4 threshold.

The ECB’s Very Disappointing December. Very Vaguely Disappointing

So let’s take a moment to summarize the ECB’s QE conundrum this year:

1. The QE program was expanding back in March from 60 billion to 80 billion euros in bond purchases each month, reflecting persistent near-deflation and weak economies.

2. The current QE program is schedule to end in March of 2017, despite the fact that the eurozone inflation levels are close to 0 percent and its economies remain extremely weak.

3. The ECB’s QE program has several self-imposed rules that determine which bonds, and in what volumes, the ECB can purchase and because of those rules and the lack of German bonds above a -0.4 percent yield, a situation was approaching were QE program couldn’t continue without breaking those rules.

4. Ireland and Portugal were also hitting a QE wall due to the QE rules that caps the total ECB bond holdings to 33 percent for a given country and had already reduced their QE bond purchases below what the “capital key” allowed because of this.

5. If Portugal’s bond rating is cut by the last remaining credit rating agency to give it an investment-grade rating, Portugal is out of the QE and back into “bailout” austerity territory.

6. Heading into the ECB’s September 8th meeting, the markets were expect an announcement of an extension of the QE program past March. That didn’t happen. Although a cut in the economic growth forecast did happen.

7. In early October, reports that the ECB was already engaging in “taper talk” confused and spooked the markets.

8. And, finally, following the election of Donald Trump, ECB officials made it clear that they saw this as increasingly, not decreasing, the risks for the eurozone economies.

And given all that, did the ECB finally drop the “capital key” or the 33 percent cap like most experts recommended so it could stop buying German bonds (driving yields deeper into negative territory) and focus on weaker economies? Of course not. Instead, it cut the minimum deposit rate to below -0.40 so it could find more eligible German bonds. And also cut the total ECB monthly QE bond purchases by 25 percent, a move widely interpreted as the start of a much-feared premature “taper”:

The Wall Street Journal

ECB Extends but Scales Back Stimulus, Whipsawing Markets
Bank’s move to buoy Europe’s economy comes days before Fed is expected to raise interest rates in U.S.

By Tom Fairless
Updated Dec. 8, 2016 3:07 p.m. ET

FRANKFURT—The European Central Bank prolonged its extraordinary lifeline to weak eurozone economies on Thursday, just days before the U.S. Federal Reserve is expected to move in the opposite direction and raise interest rates.

That divergence, along with difficulty in reading the nuances of the ECB’s action, caused investors to initially boost the euro before sending it lower as U.S. equity markets hit record highs.

The ECB surprised markets by saying it would slow the pace of its asset purchases, sparking a debate over whether the ECB had started down the path toward ending its monetary stimulus. Such a move—swiftly denied by the ECB—might be welcomed by some of the bank’s top officials, who are eager to signal an eventual exit.

Instead, the ECB’s decision was mostly taken as a sign the eurozone badly needs the type of support that the Fed next week could begin removing from the U.S., amid evidence and expectations of solid economic growth there.

The ECB said on Thursday it would extend its so-called quantitative easing program by nine months, until at least the end of next year, taking its total size above €2.2 trillion ($2.36 trillion). But starting in April, the bank will reduce the value of securities it buys per month to €60 billion from €80 billion.

Investors had considered such a move unlikely, betting that the ECB would continue to buy bonds at the current pace for at least another six months. Financial markets initially reacted negatively, with the price of shares and bonds falling sharply, and the euro rising against the dollar. Markets later reversed much of that fall.

The ECB’s decision to slightly lift its foot off the gas, as some saw it, comes despite sluggish growth and mounting political uncertainty across the 19-nation eurozone, which faces a string of major elections next year and fallout from Italy’s rejection of constitutional changes earlier this week. The move is likely to have been backed by some hawkish members of the central bank’s 25-member governing council, who have earlier signaled they seek a clear path out of the bank’s easy-money policies.

ECB President Mario Draghi took pains at a press conference Thursday to stress that the bank’s decision didn’t amount to tapering, or winding down, the bank’s stimulus. He warned that inflation in the eurozone remained too weak and said the ECB would keep buying bonds for some time.

“There is no question about tapering,” Mr. Draghi said. “Tapering has not been discussed today.”

Massive central-bank buying has helped buoy markets in recent years, and investors keep buying on the belief that such stimulus will continue. But more recently, investors have debated whether the ECB would begin to taper its aid in light of a rosier economic picture and concerns over potential side effects of its historically loose monetary policy.

On Thursday, investors decided the ECB, for now, wasn’t looking to turn off the taps.

Still, many investors weren’t convinced by Mr. Draghi’s arguments. At times on Thursday, the ECB chief veered into semantic gymnastics in an apparent effort to avoid the kind of “taper tantrum” seen in the U.S. in 2013, when the Fed suggested it might wind down its own bond-purchase program.

True tapering, Mr. Draghi argued, would involve gradually reducing the pace of bond purchases to zero. That move wasn’t discussed “and is not even on the table,” he said.

“This was a taper, as much as [Mr. Draghi] wants to deny it,” said Tim Graf, European head of macro strategy at State Street in London. But Mr. Graf welcomed said the ECB’s decision to extend its purchases for longer than expected would postpone any fresh debate on the QE program until after key European elections next year.

“The big Christmas present was time,” Mr. Graf said.

Mr. Draghi said the ECB’s decision had received “very, very broad consensus” from the bank’s 25-member governing council. Top ECB officials have been raising concerns about the adverse side effects of the bank’s easy-money policies. Bundesbank President Jens Weidmann, long an opponent of the ECB’s bond purchases, voted against Thursday’s decision.

“This is a step in the right direction,” said Clemens Fuest, president of Germany’s Ifo economic institute, a prominent critic of the ECB’s stimulus policies.

Michael Heise, chief economist at Allianz SE in Munich, pointed to the ECB’s statement that it could accelerate its bond purchases again if needed. That “can’t be described as tapering,” Mr. Heise said.

Others were less convinced. “Today was a missed opportunity to provide some sort of support to the market into a very uncertain political calendar in 2017,” said Patrick O’Donnell, an investment manager at Aberdeen Asset Management.

The ECB also announced changes to the design of its QE program on Thursday, to ensure it can continue to find enough bonds to buy. Mr. Draghi said that from January the ECB could start buying debt that yields below the minus 0.4% interest rate it pays on commercial bank deposits, something its own rules had barred it from doing. That move was aimed at addressing a scarcity of German bonds. And Mr. Draghi said that the ECB would start buying bonds with maturities of one year, down from the previous minimum maturity of two years.

The ECB also announced changes to the design of its QE program on Thursday, to ensure it can continue to find enough bonds to buy. Mr. Draghi said that from January the ECB could start buying debt that yields below the minus 0.4% interest rate it pays on commercial bank deposits, something its own rules had barred it from doing. That move was aimed at addressing a scarcity of German bonds. And Mr. Draghi said that the ECB would start buying bonds with maturities of one year, down from the previous minimum maturity of two years.”

Yes, one of the worst options the ECB had for extending its QE program – dropping the lower limit on the bond yields it could purchase so it could find more German bonds to buy – is the option it ended up going with. And while Bundesbank president Jens Weidmann voted against the ECB’s decision to extend the QE to the end of 2017, it’s hard to imagine that he wasn’t extremely pleased by the overall outcome. After all, the markets were generally expecting a QE extension heading into that meeting. But they weren’t expecting the start of a QE taper too. Or something that could be interpretted as the start of a taper. And if the president of Germany’s Ifo economic institute thinks this was a “step in the right direction”, jens Weidmann would almost certainly agree:


The ECB’s decision to slightly lift its foot off the gas, as some saw it, comes despite sluggish growth and mounting political uncertainty across the 19-nation eurozone, which faces a string of major elections next year and fallout from Italy’s rejection of constitutional changes earlier this week. The move is likely to have been backed by some hawkish members of the central bank’s 25-member governing council, who have earlier signaled they seek a clear path out of the bank’s easy-money policies.

“This is a step in the right direction,” said Clemens Fuest, president of Germany’s Ifo economic institute, a prominent critic of the ECB’s stimulus policies.

Now, keep in mind that ECB president Mario Draghi went to lengths to assure markets that this wasn’t actually the start of a true taper like Weidmann or the rest of the pro-austerity crowd would prefer. But also keep in mind that Draghi’s explanation for why this shouldn’t be interpretted as the start of a taper – that a 25 percent cut in the monthly bond purchases shouldn’t be considered the start of a taper because the cut wasn’t declared as part of an overall plan to bring the monthly asset purchases down to zero – isn’t exactly convincing. Because while it’s certainly possible that the cut in monthly bond purchases isn’t part of a secretly planned taper, it’s also the case that if the ECB wanted to start the taper now, but didn’t want to officially announce it and spook the markets, doing something like declaring this cut in bond purchases at the same time the ECB announces a 9 month extension to the QE program – when the markets were expecting a six month extension – is the kind of vague mixed messaging we might expect from the ECB.

So it’s possible we could be seeing the stealth start of a real taper. Or maybe Draghi was sincere where he said the ECB is ready to expand the QE program as needed and tthe ECB’s announcement on Dec 8 was basically a temporary compromise between the hawks and doves. But also note the other context the ECB’s decision to announce a cut in the QE while also announcing a 9 month extension of the QE program instead of the expected 6 month extension: If the ECB had announced a 6 month extension, that would set the QE program to expire in September 2017 instead of December 2017. And what’s happening between September and December of 2017? Germany’s federal elections in October.

And it’s that context that raises the question of whether or not the ECB’s surprise decisions on Dec 8 to to cut asset purchases while extending QE to the end of 2017 was basically all about trying to assuage ongoing German voter resistance to QE with a QE cut that looks like the start of a taper while also trying to avoid the need for the ECB to make a big new a public debate over what to do next debate with the QE. It would also help explain the decision to find more bonds to purchase by lowering the lower limit on eligible bond yields so the ECB can purchase more German bonds instead of other options like dropping the “capital key” which would have shifted the ECB’s focus away from a “QE that helpds everyone equally” model to a “QE that helps the countries in need the most” model.

Also don’t forget that elections in France and the Netherlands are also scheduled for next year and the far-right candidates just might win in both cases. So, if eurozone’s political zeitgiest goes horribly awry next year, we could see the AfD surging in Germany, Marine Le Pen winning in France, and Geert Wilders’s PVV dominating the Netherlands’ elections in March. Given all that, it probably wouldn’t be too suprising if the ECB decided to start signaling a QE taper simply to take to some of the political heat off the ECB in each of these looming elections in countries where the far-right is on the rise. In other words, it’s possible the ECB crafted its Dec 8 announcment for its 2017 QE specifically minimize the inevitable politicization of QE that’s guaranteed to take place next year. And yes, doing that would, itself, be an act of politicization, but it would be an act of preemptive politicization designed to reduce an expected future politicization of the ECB.

So was all that part of the ECB’s underlying logic for its December 8 QE decision? It sure seems possible, and if so, it also raises the question of just what the ECB would be doing if it was basing its decisions solely on the economics of the situation. And while we don’t get to know how the ECB would have acted under a different political environment, also note that on the same day the ECB announced is extended/tapered QE plan, it also provided its forcast for 2019. A forecast that once again predicts that the ECB will miss its goal target of hitting 2 percent inflation by 2019:

Reuters

ECB makes little change to growth and inflation forecasts

Thu Dec 8, 2016 | 8:53am EST

The European Central Bank left its economic growth and inflation forecasts largely unchanged on Thursday, predicting that price growth would raise slowly but again miss its target of close to 2 percent in 2019.

The ECB slightly increased its 2017 growth forecast to 1.7 percent from 1.6 percent seen in September and lifted its 2017 inflation forecast to 1.3 percent from 1.2 percent projected three months ago, ECB President Mario Draghi said at a news conference.

In its initial projections for 2019, the ECB put inflation at 1.7 percent, still below the target it has undershot for more than three years despite unprecedented stimulus aimed at reviving economic growth and boosting consumer prices.

“In its initial projections for 2019, the ECB put inflation at 1.7 percent, still below the target it has undershot for more than three years despite unprecedented stimulus aimed at reviving economic growth and boosting consumer prices.”

Yes, for more than three years now, the ECB has failed to meet its 2 percent inflation target and its projections for 2017-2019 continue to undershooting that target, following years of the ECB consistently overestimating its inflation projections only to later revise them lower while making new overly optimistic expectations. But despite this track record, it’s worth pointing out what the ECB did accomplish with its unprecedented monetary stimulus: avoiding the kind of outright deflation that would make the eurozone’s current economic woes look like a picnic. That’s something. It could be worse.

The Unofficial De Facto Portuguese Taper

Still, while avoiding a deflationary death spiral is indeed a positive achievement it’s not an adequate achievement. The eurozone is just one shock away from that same deflationary death spiral. So if we really are seeing the ECB “settle” for failing its 2 percent inflation target indefinitely – and that’s the message the ECB is sending when it issues a quasi-taper on the same day its 2019 inflation projections continue to fail to meet its that target – that’s rather ominous. And, unfortunately, for Portugal, the ECB’s announced QE plans are already looking rather ominous:

Reuters

Portugal’s borrowing costs move above corporates as ECB effect fades

* Portugal’s borrowing costs move higher than BB-rated companies
* QE changes favour short-dated bonds from higher-rated countries
* Possibility of DBRS downgrade hangs “like sword of Damocles”

By Abhinav Ramnarayan
Tue Dec 20, 2016 | 8:41am EST

LONDON, Dec 20 Portugal’s borrowing costs have risen above those of a group of similarly-rated European companies, on persistent concerns the European Central Bank will struggle to buy Portuguese government bonds after changes to its asset-purchase programme.

Governments tend to enjoy better borrowing rates than companies with similar credit ratings as government credit is seen as the least risky. All other borrowers pay a premium.

This effect has been exacerbated by the ECB’s bond-buying scheme, launched in March 2015 and focused on government debt. But last week the ECB made changes to the scheme that analysts said would see purchases concentrated on highly-rated bonds.

This graphic tmsnrt.rs/2hVdYBl shows how over 2016 the yield on Portugal’s 10-year government bond has, unusually, risen above the yield on an index of European corporates with the same rating as the sovereign.

Portugal 10-year bond, rated Ba1/BB+/BB+ by the three main ratings agencies, is now 13 basis points (bps) above the Reuters index of 10-year double-B-rated European corporate bonds .

By comparison, Spain’s 10-year government bond – rated BBB – yields 25 bps less than an index of triple B-rated bonds and A-rated Ireland’s 10-year bond yields 43 bps less than the single-A index.

The ECB also buys investment-grade corporate bonds under its asset-purchase scheme, albeit in much smaller volumes.

Portugal is also rated BBB (low) by DBRS, the only agency to make the sovereign investment grade. It maintained the rating in October.

“To me (the reversal) shows that the ECB support for Portugal is no longer the same and it is now trading more according to its rating,” said Commerzbank strategist David Schnautz.

“The changes to the ECB’s bond-buying programme leave Portugal hanging because they don’t address the specific problems Portugal faces in terms of QE eligibility,” he said.

Last week’s changes will allow the ECB to buy bonds with maturities of less than two years and bonds yielding less than the deposit rate.

Both changes imply the ECB will concentrate its purchases on higher-rated countries and not on the likes of Portugal, which has a limited amount of short-dated debt and no bonds yielding less than the minus 40 basis point deposit rate.

“This effect has been exacerbated by the ECB’s bond-buying scheme, launched in March 2015 and focused on government debt. But last week the ECB made changes to the scheme that analysts said would see purchases concentrated on highly-rated bonds.

So despite the fact that Portugal and Ireland were already deviating from the QE “capital key” rule and buying fewer bonds than their the capital key warranted due to concerns over the QE 33 percent cap rule, the ECB decided to lower the minimum yields on QE-purchased bond (so it could buy more German bonds without breaking the capital key for Germany) and not drop the capital keys or the 33 percent cap to make more of Portugal’s bonds available. And as analysts observe, this all indicates that the ECB is going to be concentrating its QE bond purchases on highly-rated bonds even though the whole point of some like QE is to shore up weaker bond markets and give them time and room to heal:


Portugal is also rated BBB (low) by DBRS, the only agency to make the sovereign investment grade. It maintained the rating in October.

“To me (the reversal) shows that the ECB support for Portugal is no longer the same and it is now trading more according to its rating,” said Commerzbank strategist David Schnautz.

“The changes to the ECB’s bond-buying programme leave Portugal hanging because they don’t address the specific problems Portugal faces in terms of QE eligibility,” he said.

Last week’s changes will allow the ECB to buy bonds with maturities of less than two years and bonds yielding less than the deposit rate.

Both changes imply the ECB will concentrate its purchases on higher-rated countries and not on the likes of Portugal, which has a limited amount of short-dated debt and no bonds yielding less than the minus 40 basis point deposit rate.

Both changes imply the ECB will concentrate its purchases on higher-rated countries and not on the likes of Portugal, which has a limited amount of short-dated debt and no bonds yielding less than the minus 40 basis point deposit rate.”

So the ECB’s latest QE changes appear to be oriented to allowing it to buy more German bonds and less Portugese bonds. And absolutely nothing was done about the issue of Portugal approaching that 33 percent cap. In other words, the ECB’s decision to orient its bond purchases away from Portugal is very much aligned with its decision to do nothing about that 33 cap: while it’s unclear if the overall QE program is about to undergo a taper, it’s more more clear for Portugal: Portugal’s QE participation is getting tapered one way or another.

All in all, whether or not the ECB is starting a QE taper for real or just for theatrics to placate anxious electorates, the motive for that move probably has a lot more to do with the eurozone’s political circumstances vs the macroeconomic need for more QE. And if that is the case and there really is concern at the ECB that its QE programs could become focal point for anti-eurozone partisan ire in the upcoming elections, perhaps it would be worth pointing out to those angry electorates, especially the electorate in Germany, that the rules the ECB previously put in place to ensure that QE wouldn’t help one country more than another (like the “capital keys” and “no more than 33 percent of a nation’s sovereign bonds can be held by the ECB” rules) has resulted in a situation where the countries most in need of QE support get the least. And vice versa:

The Wall Street Journal

ECB’s New Dilemma: Neediest Nations Receive Less Stimulus
Partly due to bank’s rules, its bond-buying has undershot Portugal and Ireland

By Jon Sindreu
Dec. 19, 2016 6:00 a.m. ET

When it extended its bond-purchase program this month, the European Central Bank needed to choose between buying bonds at extremely negative returns or gearing stimulus toward eurozone nations that need it the most.

It chose the former.

Every move by policy makers in the single-currency eurozone is supposed to avoid benefiting some nations over others. But now, due in part to the design of ECB rules, more stimulus is delivered to the healthiest economies and less to those that are lagging behind.

This month, ECB President Mario Draghi said the bank would extend the central bank’s asset-purchase program from its projected March end date until December 2017. This change has forced officials to relax the rules guiding the program to avoid running out of eligible bonds to buy.

The central bank has been mandated to spread its purchases according to how much capital each country has at the ECB. Keeping this quota intact has been a goal for politicians in Northern Europe, chiefly Germany, as it helps ensure countries don’t have to share the debt burdens of others through the central bank.

However, the ECB already bought debt of the eurozone’s most distressed nations under an emergency program from 2010 to 2012 and is now having to buy less from these countries than national quotas would dictate.

This is because the ECB had two other main self-imposed rules constraining its actions. First, it isn’t allowed to own more than one-third of a single issuer’s outstanding debt. Second, it couldn’t buy bonds with yields below its own deposit-facility rate, currently at minus 0.4%.

As a result, since it expanded bond buying in March, the ECB has undershot Portuguese bond purchases by well over €3 billion ($3.1 billion) and overshot purchases in Germany by €8 billion.

The aim of the bond-buying program is to help the economy by lowering borrowing costs further, and Portugal clearly needs it more: Its 10-year government yield is almost at 4%, second only to that of Greece, reflecting a foundering economy. In Germany, a country at full employment, the 10-year yield is close to 0.3%.

But the central bank’s decisions this month did little to address concerns that it will keep undershooting purchases in the neediest nations.

“We don’t think the ECB announcement is good for the periphery,” said Bert Lourenco, head of rates strategy for Europe, Middle East and Asia at British lender HSBC Holdings PLC.

To expand the pool of eligible assets, officials chose to remove the prohibition to buy bonds below the minus-0.4% deposit rate, which will allow the ECB to buy more German and Dutch bonds. They didn’t touch any of the main obstacles that are driving the central bank to buy less in Portugal and Ireland.

The reason, Mr. Draghi said, is that “there was an increasing awareness of the legal and institutional constraints that would make such a change difficult.”

The decision isn’t painless for Germany, either. When the ECB buys a bond yielding, for example, minus-0.5%, it does so by creating a deposit in its own accounts. If the rate it pays on this deposit is minus-0.4%, it means it is getting less from the bond than it is paying, exposing itself to losses.

In reality, national central banks do most of the purchases at the ECB’s behest, and yields are only negative in the safest eurozone nations. In Germany, all bonds up to five years of maturity return less than minus-0.4%. This means that removing this rule will hurt, most of all, the German Bundesbank’s profits.

Still, “the Germans prefer to take the heat on their own purchases than to relax constraints on the periphery,” said François Savary, chief investor at Geneva-based advisory firm Prime Partners. “It’s a political choice.”

To be sure, these bonds may still prove profitable if rates go lower in the future. And even if some specific bonds generate paper losses, overall purchases are unlikely to.

Also, the stimulus ideally reaches beyond borders. Germans, for example, may use lower borrowing costs to import more products from Portugal.

But some investors see the inflexibility of the rules as another concerning sign of the political struggle of the eurozone to stay together.

While profits and losses don’t theoretically mean much to central banks, they often do in practice.

Bundesbank President Jens Weidmann spoke against the removal of the deposit floor earlier in the year, while German economists—like Hans-Werner Sinn, president of the Ifo Institute for Economic Research—have often suggested all of the ECB’s actions end up hiding under-the-table bailouts for southern European countries.

Any step toward aiming monetary policy at the neediest countries has long been politically controversial and challenged in German and European courts. Some fear these constraints on the ECB could impair its ability to deliver more stimulus.

“Political constraints appear to now be dominating,” Bank of America Merrill Lynch told its clients last week. “Come another large shock, the central bank would have little ammunition left.”

“Every move by policy makers in the single-currency eurozone is supposed to avoid benefiting some nations over others. But now, due in part to the design of ECB rules, more stimulus is delivered to the healthiest economies and less to those that are lagging behind.

And that’s where we are with the ECB’s QE: the healthiest economies get the greatest benefit while the countries that most need that QE stimulus are getting slowing pushed out of the program:


This month, ECB President Mario Draghi said the bank would extend the central bank’s asset-purchase program from its projected March end date until December 2017. This change has forced officials to relax the rules guiding the program to avoid running out of eligible bonds to buy.

The central bank has been mandated to spread its purchases according to how much capital each country has at the ECB. Keeping this quota intact has been a goal for politicians in Northern Europe, chiefly Germany, as it helps ensure countries don’t have to share the debt burdens of others through the central bank.

However, the ECB already bought debt of the eurozone’s most distressed nations under an emergency program from 2010 to 2012 and is now having to buy less from these countries than national quotas would dictate.

This is because the ECB had two other main self-imposed rules constraining its actions. First, it isn’t allowed to own more than one-third of a single issuer’s outstanding debt. Second, it couldn’t buy bonds with yields below its own deposit-facility rate, currently at minus 0.4%.

As a result, since it expanded bond buying in March, the ECB has undershot Portuguese bond purchases by well over €3 billion ($3.1 billion) and overshot purchases in Germany by €8 billion.

“As a result, since it expanded bond buying in March, the ECB has undershot Portuguese bond purchases by well over €3 billion ($3.1 billion) and overshot purchases in Germany by €8 billion.”

That’s the situation: Thanks to all the self-imposed rules the ECB put in place in order to avoid any possibility that the QE program could end up helping one eurozone country more than another, largely at the behest of the eurozone’s wealthier members like Germany and the Netherlands, the ECB’s QE is now more of a stimulus program for Germany than countries the like Portugal that actually need it. Will that little fun-fact end up penetrating the far-right “populist” fervor bound to dominate the political scene in next year’s critical eurozone elections? Probably not, but it should.

Discussion

6 comments for “The New World Ordoliberalism Part 6: The QE Taper Caper and the Portuguese Squeeze”

  1. Here’s an article with a headline that we’re probably going to see a lot more in comings months: “ECB slashes purchases of Portuguese debt as limit looms”:

    Reuters

    UPDATE 1-ECB slashes purchases of Portuguese debt as limit looms

    * ECB buys 40 pct fewer Portuguese bonds than rules dictate

    * Portuguese inflation still low, outlook uncertain

    * Frankfurt wary of hitting issuer limit (Recasts, adds detail)

    By Francesco Canepa
    Tue Jan 3, 2017 | 11:57am EST

    FRANKFURT, Jan 3 The European Central Bank bought far fewer Portuguese government bonds last month than its rules dictate, reducing its support for a country where government borrowing costs are rising and the economic outlook is uncertain.

    With its bond-buying scheme set to continue at least until December, the ECB has slowed down monthly purchases in Portugal to avoid hitting a limit on how much of the country’s debt it can own.

    The reduction in ECB purchases has never been as marked as in December, when the ECB bought 726 million euros worth – 40 percent less than it should have according to its own rules.

    This reduced support has already taken a toll on Portugal, where government borrowing costs rose last year for the first time since 2011.

    At the start of its programme, the ECB said it would buy government bonds according to how much of the ECB’s own capital each country had paid.

    On this measure, Portugal should account for around 2.5 percent of all euro zone government bonds bought by euro zone central banks, but they only made up 1.5 percent of the total in December.

    Purchases of Irish bonds were also short of that country’s share of the capital key last month, albeit to a lesser extent.

    The ECB is already nearing a self-imposed limit of holding a third of both countries’ debt due to the large amounts of bonds it bought under previous crisis-fighting measures.

    If it touches that limit, it would have to stop buying Portuguese bonds altogether. That would likely have severe consequences on the Portuguese government’s borrowing costs and its ability to spend.

    “The reduction in ECB purchases has never been as marked as in December, when the ECB bought 726 million euros worth – 40 percent less than it should have according to its own rules.”

    Keep in mind that as Portugal creeps closer and closer to the 33 percent cap
    each month these QE cuts are only going to grow. And yes, that means the ECB’s QE program is now basically pulling support from one of its weakest economies just as its fragile recovery is getting underway. And it’s all being done in the name of “fairness” and “playing by the rules” or whatever particular rational the eurozone finance ministers used to justify their decision in early December to tweak the rules to allow more German bond purchases over more Portuguese and Irish purchases (and maybe possibly Greek purchases if the Troika allows Greece to leave its “bailout” status).

    Although it’s worth noting that there is talk of a possible plan that could help the Irish get around their own 33 percent ceiling. Sort of. The plan wouldn’t eliminate the reduced ECB purchases of Irish bonds but it would at least limit the scale of the reduction: Before the December 8th meeting last month, the ECB was estimated to hold ~31 billion in Irish bonds, which is at 97 percent of that 33 cap. One way to address this is for Ireland to simply issue more bonds, thus increasing the total size of the Irish bond market and pushing up the available cap. The plan right now is to hopefully issue 13 billion euros in new bonds, which should add another 4.25 billion euros to that 33 percent cap.

    A second way to address the cap has to be much more embittering for Ireland: It has to do with the fact that The ECB is still holding billions of euros in bonds in the Anglo Irish, the large Irish bank that imploded that was heavily involved in financing Ireland’s housing bubble (with the immense help of foreign lenders) and was nationalized in 2009 when that bubble burst, largely as a bailout to foreign (heavily French and German) lenders. And that nationalization of private (foreign lender) debt, in turn, sent Ireland itself into a downward spiral leading to the “bailout” of Ireland in 2010. And all the austerity that followed. The more of those Anglo Irish bonds the ECB takes off its books the more Irish bonds it can buy with the QE program.

    So if Ireland issues as much new debt as possible and the ECB sells as many Anglo Irish bonds as its scheduled to sell, Ireland might be able to turn a project 50 percent reduction to maybe just a 30 percent reduction in ECB purchases of Irish bonds in its QE program. And most of those Anglo Irish bonds are getting sold back to Ireland as is. As long as Ireland keeps buying a bunch of Anglo Irish bonds it might be able to blunt the reduction in its QE participation. Whoopie:

    The Irish Times

    ECB Irish bond restrictions may be eased by NTMA, Central Bank
    ECB likely to be able to limit fall-off in Irish bond purchases to less than 30 per cent

    Joe Brennan
    Wed, Dec 21, 2016, 06:08

    The European Central Bank will be able to buy more Irish bonds than feared next year, if the State’s debt agency issues the maximum €13 billion of bonds it has targeted for 2017 and the Central Bank keeps selling bonds linked to Anglo Irish Bank’s bailout at pace.

    Economists were surprised on December 8th when the ECB extended the lifespan of its huge stimulus programme to the end of next year, but failed to ease the terms attached to it. These terms restricted the ECB to buying no more than 33 per cent of eligible bonds from a single state and 33 per cent of any individual bond in issue, which put Ireland and Portugal at an immediate disadvantage to other euro zone countries.

    Before the ECB meeting, Cantor Fitzgerald’s head of fixed-income strategy in Dublin, Ryan McGrath, estimated that euro zone central banks held about €31.34 billion of eligible Irish bonds under the quantitative easing plan. That equated to over 97 per cent of the maximum amount Mr McGrath estimated the ECB could buy, based on the strict conditions attached to the programme.

    Sources said, after the ECB governing council meeting, that even with further planned government debt sales and other actions next year, the amount of Irish bonds acquired each month by the ECB would be likely to drop by about 50 per cent to €400 million a month.

    However, market sources said on Thursday it is likely the ECB, through the Central Bank in Dublin, will be able limit the fall-off in Irish bond purchases next year to less than 30 per cent.

    NTMA

    That’s partly based on the National Treasury Management Agency selling the maximum €13 billion of bond sales it has targeted for next year, which the debt agency announced last week.

    It also assumes the Central Bank keeps up the pace of selling off bonds relating to the bailout of Anglo Irish Bank.

    The securities are the result of the Central Bank receiving €25 billion of government bonds in 2013 under a complex restructuring of promissory notes used by the State during the crisis to rescue the bank.

    The Central Bank sold €3 billion of these bonds to the NTMA this year, including a €500 million tranche on Thursday. Last year, the NTMA bought €2 billion’s worth of such bonds from the Central Bank.

    “Before the ECB meeting, Cantor Fitzgerald’s head of fixed-income strategy in Dublin, Ryan McGrath, estimated that euro zone central banks held about €31.34 billion of eligible Irish bonds under the quantitative easing plan. That equated to over 97 per cent of the maximum amount Mr McGrath estimated the ECB could buy, based on the strict conditions attached to the programme.”

    That’s how close Ireland is to its 33 percent cap: it’s already 97 percent of the way there. If it issues the maximum of 13 billion euros in new debt in 2017 that will free up another 4.25 billion for QE purchases. But if it’s going to raise that cap more, it’s going to have to buy more of those Anglo Irish bonds first. It bought 3 billion euros in bonds in 2016 last year, 2 billion in 2015, and we’ll find out what it buys in 2017 but it will probably be a lot. And when we do find that out we’ll also find out what the ECB’s participation in Ireland’s QE will be. The QE that’s supposed to help countries like Ireland.

    So Ireland basically has to borrow to buy back the Anglo Irish bonds – bonds which were privately held until Ireland nationalize the bank to bail out Anglo Irish’s foreign (mostly French and German) creditors and which caused Ireland’s years of austerity – in order to avoid seeing its participation in the QE program grinding to a halt.

    Usury can get pretty convoluted at times. Especially at the nation state level.

    Posted by Pterrafractyl | January 3, 2017, 8:09 pm
  2. Here’s a sign of hope for the eurozone’s future, although it comes in the form of a warning about the eurozone’s possible doom from Sigmar Gabriel, the likely choice of the SPD to face off against Merkel in this year’s elections, so it’s not super hopeful. Still, it’s nice to see sane warnings of doom from Germany’s politicians. You’ve got to take hope where you can find it when doom looms:

    Reuters

    Germany’s Gabriel says EU break-up no longer unthinkable
    Sat Jan 7, 2017 | 10:21am EST

    Germany’s insistence on austerity in the euro zone has left Europe more divided than ever and a break-up of the European Union is no longer inconceivable, German Vice Chancellor Sigmar Gabriel told Der Spiegel magazine.

    “I once asked the chancellor, what would be more costly for Germany: for France to be allowed to have half a percentage point more deficit, or for Marine Le Pen to become president?” he said, referring to the leader of the far-right National Front.

    “Until today, she still owes me an answer,” added Gabriel, whose SPD favors a greater focus on investment while Merkel’s conservatives put more emphasis on fiscal discipline as a foundation for economic prosperity.

    The SPD is expected to choose Gabriel, their long-standing chairman who is also economy minister, to run against Merkel for chancellor in September’s federal election, senior party sources said on Thursday.

    Asked if he really believed he could win more votes by transferring more German money to other EU countries, Gabriel replied: “I know that this discussion is extremely unpopular.”

    “But I also know about the state of the EU. It is no longer unthinkable that it breaks apart,” he said in the interview, published on Saturday.

    “Should that happen, our children and grandchildren would curse us,” he added. “Because Germany is the biggest beneficiary of the European community – economically and politically.”

    “Asked if he really believed he could win more votes by transferring more German money to other EU countries, Gabriel replied: “I know that this discussion is extremely unpopular.””

    Well, with the SPD’s likely candidate for Chancellor talking about the need fiscal transfers and warn against the dangers of austerity, maybe the eurozone isn’t entirely doomed. It’s still not the best sign since no one is expecting the SPD to defeat the CDU. Although it’s possible we could see the SPD come out head if the far-right surges and the AfD does much better than expected by stealing away the CDU’s votes. Of course, that’s still an awful scenario. And if both Merkel and the AfD campaign in favor of more austerity and against the ECB’s QE and end up trouncing the SPD, things could be extra bad.

    So while it is indeed a sign of hope that Sigmar Gabriel is signaling that he’ll push an anti-austerity theme in his likely campaign against Merkel this year, it’s a sign of hope in the form of an honest warning about looming doom. It’s not super hopeful.

    Of course, since politically unpalatable things like fiscal transfers from rich to poor countries are probably both necessary for the eurozone to function and psychologically impossible to get the populace to agree to, it’s not entirely clear that the eurozone really can realistically ever achieve the political zeitgeist required for it to function economically and, in turn, function politically. So it’s not really clearly that it’s in anyone’s best interests for the eurozone to continue at all in the long-run, in which case those warnings from Gabriel of the eurozone’s possible doom are also signs of hope in the sense that the eurozone’s doom is itself a hopeful event.

    All in all, there’s no shortage of hopeful doom looming over the Europe in 2017. There’s no shortage of doomful doom either.

    Posted by Pterrafractyl | January 8, 2017, 11:38 pm
  3. Oh great. Guess which eurozone member just experienced a “surge” in inflation. A “surge” all the way up to 1.7 percent. Thanks almost entirely to rising oil prices:

    Bloomberg

    German Inflation Jumps to Fastest Since 2013 on Oil Prices

    by Piotr Skolimowski

    January 3, 2017, 7:00 AM CST January 3, 2017, 7:57 AM CST

    * Consumer prices rose annual 1.7% this month vs 1.3% estimate
    * Euro-area inflation report due to be published on Wednesday

    The pace of German inflation more than doubled in December, driven by a surge in oil that is set to mask continued weakness in underlying price pressures in the months ahead.

    Consumer prices rose 1.7 percent from a year ago, recording the biggest jump on record, the Federal Statistics Office in Wiesbaden said on Tuesday. Economists surveyed by Bloomberg predicted an increase to 1.3 percent. The reading is the strongest since July 2013 and follows a rate of 0.7 percent the previous month. Prices rose 1 percent from November.

    The increase takes inflation in the region’s largest economy close to the European Central Bank’s definition of price stability of just under 2 percent, providing ammunition for some officials pushing for a gradual exit from unconventional stimulus. President Mario Draghi has argued that a decision last month to extend bond buying for longer than anticipated but at a slower pace reflected a “firming” euro-area recovery and “still subdued” core price gains.

    “The key question will be by how much higher energy prices will feed into other prices,” said Holger Sandte, chief European analyst at Nordea Markets in Copenhagen. With the main driver of the December pickup a base effect from past oil-price declines, “we expect a very gradual increase in core inflation both for Germany and the euro area.”

    The euro was little changed after the report and traded at $1.0389 at 2:57 p.m. Frankfurt time.

    The cost of Brent crude surged 12.6 percent in December, recording the biggest monthly increase since April. Prices are set to rise further as the Organization of Petroleum Exporting Countries and 11 other nations started to cut output on Jan. 1 in an effort to reduce bloated global inventories.

    Energy Prices

    Prices for heating oil in Germany rose annually for the first time in four years in December. Most states reported increases of more than 20 percent, contributing as much as 0.3 percentage point to inflation rates.

    Fuel was also significantly more expensive, with year-over-year price gains exceeding 5 percent in all regional reports published Tuesday. Food prices jumped at least 3 percent in the majority of states.

    In France, consumer prices increased 0.8 percent in December from a year earlier, the most since May 2014, according to a separate report. Spanish inflation accelerated to 1.4 percent, the highest rate since mid-2013.

    “The increase takes inflation in the region’s largest economy close to the European Central Bank’s definition of price stability of just under 2 percent, providing ammunition for some officials pushing for a gradual exit from unconventional stimulus. President Mario Draghi has argued that a decision last month to extend bond buying for longer than anticipated but at a slower pace reflected a “firming” euro-area recovery and “still subdued” core price gains.”

    So Germany experiences an oil-induced one month surge in inflation due largely to a surge in oil prices, bringing German inflation all the way up to whole 1.7 percent.

    And what happened next? A clamor in Berlin for an end to the ECB’s QE and a hike in rates, of course:

    The Financial Times

    Soaring eurozone inflation presents ECB with dilemma

    Increase to 1.1% revives rate rise calls but analysts say region’s economy still weak

    January 4, 2017

    by: Claire Jones in Frankfurt

    Surging eurozone inflation looks set to leave the European Central Bank caught between appeasing German advocates of higher interest rates and assuring fearful investors that it has no plans to further trim its bond purchases just yet.

    Annual inflation in the single currency area has soared to its highest level since 2013, climbing to 1.1 per cent in December, according to data released by Eurostat, the European Commission’s statistics bureau, on Wednesday.

    While the year-on-year reading, the first above 1 per cent since September 2013, has revived Berlin’s calls for rate rises, market analysts say the eurozone economy is still weak and the bank must press on with plans to buy bonds worth €780bn this year under its landmark quantitative easing programme.

    Politicians in the eurozone’s strongest economy were quick to use higher inflation, which in Germany is now 1.7 per cent, to ramp up pressure on the ECB to abandon the low interest rate policy they say is robbing citizens of their savings.

    Handelsblatt, the business daily, on Wednesday led its front page with the headline: “Trapped by Low Interest Rates.”

    Speaking to the Financial Times, Wolfgang Steiger, general secretary of the economic council of Chancellor Angela Merkel’s CDU party, said: “The alleged spectre of deflation can no longer serve as justification for monetary policy’s doping effects [on the eurozone economy].

    “For the saver, the combination of rising inflation and zero rates is a dramatic destruction of the value of their money. It is all the more urgent that the race towards ever more unconventional central bank actions is finally stopped.”

    Alexander Radwan, a member of the CDU’s sister party, the CSU, said: “The exit from the zero-interest rate policy is difficult and lengthy…That is why we must begin now.”

    The calls from Germany are likely to grow louder as the headline inflation rate ticks up in the coming months. With the country heading to the polls later this year, criticism of the ECB is one way to win favour with an electorate that has become more Eurosceptic.

    Despite the headline number climbing sharply from November’s 0.6 per cent, core inflation, which strips out volatile energy and food prices, inched up only slightly to 0.9 per cent in December from 0.8 per cent.

    “The calls from Germany are likely to grow louder as the headline inflation rate ticks up in the coming months. With the country heading to the polls later this year, criticism of the ECB is one way to win favour with an electorate that has become more Eurosceptic.”

    As we can see, slamming the ECB’s efforts to hold the eurozone together and demanding an immediate rates hikes and an end to QE all to protect savers – savers who apparently don’t care if there’s another eurozone crisis – is going to be one of the methods of choice for German politicians running the German version of a Trumpian campaign in 2017:


    Speaking to the Financial Times, Wolfgang Steiger, general secretary of the economic council of Chancellor Angela Merkel’s CDU party, said: “The alleged spectre of deflation can no longer serve as justification for monetary policy’s doping effects [on the eurozone economy].

    Yes, the threat of deflation for the eurozone as a whole is merely an “alleged spectre” now that Germany, the eurozone’s strongest economy, managed to experience a one-month oil-spike-induced rise in inflation to a level that’s still below the ECB’s 2 percent target. And despite the fact that the rest of the eurozone’s core inflation rate is up a whole 0.3 percent above its all time low:

    Bloomberg Markets

    Why It’s Too Soon for Draghi to Celebrate the Return of Inflation

    by Carolynn Look
    and Fergal O’Brien
    January 4, 2017, 4:00 AM CST January 4, 2017, 8:26 AM CST

    * Consumer prices rise 1.1%, core inflation increases to 0.9%
    * Germany surprised with record inflation surge on Tuesday

    The euro area’s deflation scare has abated, but it may not yet be time for Mario Draghi to sound the all-clear.

    While the region is experiencing the fastest consumer-price growth in more than three years, it’s still only at about half the pace of where the European Central Bank president would like it. At the same time, the core measure is even lower. It stood at 0.9 percent in December — a five month high, but still only 0.3 percentage point away from its all-time low two years ago.

    The question for the ECB’s Governing Council, which announced an extension of quantitative easing last month, is whether this is part of its long-awaited “sustained adjustment” in inflation or a technical move related to commodity prices and a weaker currency. Along with continued signs of economic growth, the data may reinforce the position of the central bank’s hawkish officials as they prepare for their first policy meeting of the year in two weeks.

    “Underlying inflation, which is what the ECB is most worried about, is really going nowhere,” said Jamie Murray, an economist at Bloomberg Intelligence in London. “It will keep policy loose. We’re going to see some movement in headline inflation, but the ECB is focused on core and underlying and that’s what matters.”

    Even so, Bundesbank President Jens Weidmann has argued in favor of a swift unwinding of stimulus once price growth allows, and Executive Board member Benoit Coeure told Boersen-Zeitung last week that inflation could face upside risks.

    “While the region is experiencing the fastest consumer-price growth in more than three years, it’s still only at about half the pace of where the European Central Bank president would like it. At the same time, the core measure is even lower. It stood at 0.9 percent in December — a five month high, but still only 0.3 percentage point away from its all-time low two years ago.

    That “spectre” of deflation sure is persistently haunting. But how about we ignore that and repeat the ECB’s disastrous rates hikes of 2011 instead. The same rate hikes that led to the ECB’s 2012 pledge to “do whatever it takes” to avoid a collapse of the eurozone. That same pledge that’s still in effect today. How about we ignore all that so German savers can make a little bit more in interest.

    And that’s part of what’s so scary about the eurozone: Thanks largely to the pro-austerity/pro-deflation far-right economic ideology that dominate the thinking in the most powerful nations in the eurozone, the Ghost of Policy Mistakes Past is generally the Ghost of Policy Mistakes Present and Future too. It’s a “spectre” that’s unfortunately very real.

    Boo.

    Posted by Pterrafractyl | January 11, 2017, 11:52 pm
  4. hings are heating up in Portugal’s bond markets. Or cooling off. Or both. Demand is cooling off for Portuguese bonds and that’s heating up the tensions between Portugal’s looming ECB QE dilemma – hitting that 33 percent cap of total issued bonds that the ECB can purchase as part of its QE program according to its self-imposed rules – and the possibility that a single ratings downgrade could end up knocking Portugal’s credit rating into junk status and knocking it out of the QE program altogether. So while there isn’t a clear temperature-based metaphor for the situation since demand is cooling, ‘increasingly strained’ is an apt description.

    But before we take a look at the current situation, let’s go back to early October of last year, when it still wasn’t clear if Portugal was going to keep its above-junk credit rating (which it kept on October 21 when DBRS – the last ratings firm to give Portugal and investment grade on its debt – decided to maintain that rating) and it also still wasn’t clear that the ECB was going to totally screw Portugal in the QE program by refusing to raise the 33 percent cap on the total percent of a country’s bonds the ECB could purchase for the program (which happened on December 8 when the ECB decided to totally screw Portugal). And of course, things were increasingly strained in general. So strained, as we’ll see, that Portugal had to cancel plans for a round syndicated bond issuance (bonds that are sold by a government to a handful of banks who resell them, as opposed to a normal bond auction to a broader market). And when a sovereign nation starts getting frisky about its syndicated bonds, things are generally looking a little ominous, as was the case for Portugal back in early October.

    But before we take a look at that early October ominousness, let’s take a quick look at the nice article describing what syndicated bonds are and why they’re something a country facing troubles in the bond market might want to consider. The article is from early 2010 and about Greece’s decision that year to start issuing syndicated bonds. This is, of course, shortly before Greece got its first “bailout”/austerity treatment in May 2010 that doomed it to years of austerity. Again, nation states don’t generally want to issue syndicated bonds unless they have to:

    Reuters

    What’s a syndicated bond?

    By Felix Salmon
    March 31, 2010

    The term has been around for a little while now, but only recently has the concept of a syndicated bond been commonplace in news stories, and it seems to have arrived without anybody explaining what it is.

    Most of the references to syndicated bonds are coming from Greece these days, so I phoned up George Georgiopoulos, Reuters’s man in Athens, and got him to explain them to me.

    The confusing thing here is that only sovereigns issue syndicated bonds, because only sovereigns don’t issue syndicated bonds.

    OK, let me try again. As a base case, essentially all bonds are syndicated. If a company wants to issue bonds, it will find a group of banks to underwrite its bond issue and sell those bonds to investors. And if a sovereign wants to issue bonds in a foreign currency, it will do the same thing. None of these bonds are ever referred to as “syndicated bonds”, though — they’re just old-fashioned bonds, or global bonds, or whatever. The existence of a bookrunner and an underwriting syndicate is simply taken for granted.

    The exception to that rule is when governments issue debt in their own currency. Normally, that kind of thing is handled through auctions, where a group of primary dealers, who promise to make a market in government debt, bid on new issuance. It’s always possible, however, that such an auction might fail, and that the government won’t be able to issue all the debt that it wants, for lack of bids from the primary dealers.

    So Greece has started issuing occasional syndicated bonds, where it does just what companies do when they want to issue debt: it gets a small syndicate of banks together, and the banks underwrite the bond, promising to buy it if there aren’t enough bids in the market. Then they go out and build a book and sell the bond to investors just like they would with a corporate issue. This way of doing things guarantees that the government will be able to sell all the bonds it wants to sell.

    Think of it this way: most bonds are syndicated, while government bonds are auctioned. If you see a reference to a “syndicated bond”, that means that a government is not auctioning its bonds, and has decided to syndicate them instead.

    “So Greece has started issuing occasional syndicated bonds, where it does just what companies do when they want to issue debt: it gets a small syndicate of banks together, and the banks underwrite the bond, promising to buy it if there aren’t enough bids in the market. Then they go out and build a book and sell the bond to investors just like they would with a corporate issue. This way of doing things guarantees that the government will be able to sell all the bonds it wants to sell.”

    So that was Greece in early 2010: when uncertainty is high in the bond markets it’s a good time for syndicated bonds…because it’s a bad time in general. Now, flashing forward to early October of last year and flashing over to Portugal, we find a level of ominousness that Portugal had to cancel a planned syndicated bond issuance. It was pretty ominous:

    Reuters

    Portugal knocks syndication plans on head, DBRS looms closer

    * Syndication not mentioned in Q4 plans

    * Investment-grade rating hangs by thread

    By Helene Durand and Laura Benitez
    Thu Oct 6, 2016 | 10:12am EDT

    LONDON, Oct 6 (IFR) – Portugal has quietly ditched plans to raise funding via a syndication as concerns around the sovereign’s eligibility for the ECB QE programme continue to pressure the country’s bonds.

    The sovereign in its third quarter guidelines had announced its intention to issue bonds using a combination of syndications and auctions.

    However, the mention of a possible syndication was dropped on Monday when the sovereign released guidelines for Q4.

    Unlike auctions, which tend to be run-of-the-mill affairs, syndications can leave sovereigns more exposed to execution risk as banks need to find enough demand to cover a transaction.

    While Portugal’s Q4 statement said it would continuously monitor market conditions and that this may result in a change of the guidelines, the sovereign has little chance to access the market until October 21 at the earliest.

    That is when DBRS will say whether it has kept Portugal’s rating in investment-grade territory – the last thread keeping the country’s debt eligible for the ECB purchase programme.

    “If there is a way for Portugal to remain in the QE programme, then their funding programme can go on as planned,” said John Taylor, portfolio manager, fixed income at Alliance Bernstein.

    “If that isn’t the case, there would be a negative reaction in the market and it’s difficult to say exactly what sort of impact that would have on their yield and spread.”

    Ten-year Portuguese government yields have risen since the beginning of the year as concerns around the health of the country’s economy and banking sector have escalated.

    They were quoted at 3.52% on Thursday afternoon, having started the year at 2.56%, according to Thomson Reuters data.

    “Portugal is already trading around 250bp wide of Spain so the market is acknowledging this risk to some extent,” said Taylor.

    “Greece is yielding 8.5% versus 3.5% for Portugal and is much lower rated but does indicate that Portuguese yields could move quite a long way in this scenario.”

    Things have not been helped by comments made by DBRS’s head of sovereign ratings. He told Reuters in the middle of August that while the outlook on the sovereign’s BBB (low) rating remained stable, pressures appeared to be mounting.

    He told the FT on Thursday that Portugal was in a “vicious circle” and had “large structural problems.”

    Moody’s and Fitch downgraded the sovereign to junk at the end of 2015, to Ba1 and BB+, joining S&P, which already rated it at BB+.

    FALLING BEHIND

    The failure to conduct a syndication in the third quarter has also meant Portugal could now fall short of the 18bn-20bn gross issuance target it had outlined for 2016.

    According to a presentation dated September 22, the IGCP said it had raised 13bn of medium and long-term debt between January and July this year. Since then, it has raised 1.75bn in two auctions. Even if Portugal manages to print the upper end of the auction amounts it has outlined for Q4, it will still fall short of its yearly target, potentially by as much as 3.25bn.

    “While Portugal’s Q4 statement said it would continuously monitor market conditions and that this may result in a change of the guidelines, the sovereign has little chance to access the market until October 21 at the earliest.”

    Yeah, while it’s not necessarily a horrible sign when a country is resorting to syndicated bonds it’s still not the best sign – since that implies that it’s going to pay a higher interest rate to essentially pay for a handful of larger banks to find the rest of the buyers for those bonds (the large banks buy all the bonds in the syndicated issuance and then resell them) – but it’s a much worse sign if you need to cancel your syndicated bond issuance. But it was also not at all surprising for Portugal to run into these troubles given what it was facing in early October of last year. It’s not easy issuing new bonds, syndicated or otherwise, when the country is sitting there and waiting for a single ratings agency to maintain its non-junk credit rating.

    Of course, the Canadian ratings firm DBRS did indeed uphold Portugal’s non-junk status a couple weeks later (for now). And then the ECB decided to totally screw Portugal in early December (forever, seemingly). Two steps forward and two steps back. And that brings us to today. Or, rather, a week and a half ago when Portugal was facing the toughest bond sale in years and these are syndicated bond it’s selling:

    Reuters

    Portugal seeks to raise funds in toughest bond sale in years

    * Syndicated sale could come soon: financse minister

    * Banking crisis, lack of ECB support add to market concerns

    * Investor warns downgrade could push Portugal out of market

    * Steep curve makes selling 10-year benchmark challenging

    Abhinav Ramnarayan
    Monday, 9 Jan 2017 | 12:52 PM ET

    LONDON, Jan 9 (Reuters) – Portugal is seeking to raise funds through a syndicated sale of bonds just as a persistent banking crisis, reduced support from the European Central Bank and a sluggish economy have pushed its borrowing costs to one-year highs.

    Portugal’s finance minister Mario Centeno told Reuters in an interview that a syndicated bond issue — under which banks distribute new bonds to a variety of investors — is likely to be launched soon.

    Two primary dealers said Portugal’s debt office is monitoring the market and a deal could be launched as early as this week.

    But investors have turned wary of Portugal’s government bonds as the threat of a credit rating downgrade to junk and reduced ECB purchases have sent borrowing costs spiking to their highest level in years.

    Ten-year bond yields have risen nearly 50 basis points in the past four weeks to top 4 percent for the first time in nearly a year. On Monday the 10-year benchmark bond hit a high of 4.2 percent.

    Apart from a couple of brief spikes in February 2016, the last time the bond yielded more than 4 percent on a sustained basis was back in August 2014.

    “This means you get additional yield as an investor, but obviously there’s a reason why you get that additional yield – and the drivers for the rise in yields are not exhausted yet,” said Commerzbank strategist David Schnautz.

    “There is still a clean-up of the banking sector that needs to be done and the other elephant in the room is the ECB – they are close to the limit of Portuguese government bonds they can buy.”

    Many expected the ECB to remove a cap on the percentage of government bonds it can own to allow for more purchases of Portuguese government bonds, among others, to alleviate a shortage of assets for its bond-buying scheme.

    But the central bank chose to enact other measures, such as buying bonds that yield below the deposit rate, to solve that issue – a change that suggests it would concentrate purchases on higher-rated euro zone governments such as Germany.

    Indeed, the ECB bought far fewer Portuguese government bonds last month than its rules dictate, as it approaches that ceiling.

    Rabobank analysts believe the ECB could hit the ceiling by June this year, factoring in potential new bond issuance by Portugal and changes to the bond-buying scheme.

    ACCESS THREAT

    Bluebay Asset Management portfolio manager Mark Dowding said there is even a risk that Portugal could, in the worst case, end up losing market access.

    “You can imagine a sequence of events where there’s a negative development in the banking sector, or Portugal loses its investment-grade rating, spreads would go from 350 basis points to 450 basis points,” he said, referring to the extra yield investors might demand to hold Portuguese rather than German bonds.

    “In the meantime, Bund yields will have gone higher and Portugal could have to pay 5 percent on its debt, debt to GDP (gross domestic product) would rise and there is no one to bail them out and it enters a death spiral,” he said last month in the aftermath of the ECB’s changes to its bond buying program.

    January is traditionally a busy month for European government bond issuance, and Portugal has chosen this month to sell syndicated debt for the past four years.

    Its primary dealers say this year’s sale will be more challenging than at any point since the euro zone debt crises of 2010-2012.

    In the last two years Portugal has issued new 10-year benchmark bonds in January, but this time “the steepness of the curve represents a challenge,” one primary dealer said. “If you look at the (yield) difference between Spain’s five-year and 10-year bonds, it is around 120 basis points. For Portugal it is over 200 bps – that’s a very, very steep curve,” said one.

    “From a cost financing perspective it makes sense for them to do something shorter.”

    However, issuing a very short-dated bond may defeat the purpose of syndication, as such bonds are generally sold via auctions.

    “They have a difficult decision to make – they generally issue a 10-year at this time of the year, but a five- or a seven-year would make more sense,” said a second primary dealer. “It is not a slam dunk by any means.”

    “But investors have turned wary of Portugal’s government bonds as the threat of a credit rating downgrade to junk and reduced ECB purchases have sent borrowing costs spiking to their highest level in years.”

    Yeah, that’s not good. Or to put it another way, it hasn’t been this bad since the 2010-2012 period when the early pre-QE phase of the eurozone crisis was unfolding…which is another way of saying it’s pretty bad:

    Its primary dealers say this year’s sale will be more challenging than at any point since the euro zone debt crises of 2010-2012.

    Yeah, that doesn’t sound good. Or cheap.

    So what’s the ECB going to do with Portugal’s bond markets continuing to flash warning signs? Is the eurozone’s central bank going to just let another eurozone country drift into the “bailout” zone? Because that’s what will happen if things continue to get worse. That remains to be seen but keep in mind that the fewer bonds Portugal can issue the fewer bonds the ECB can purchase in the QE. That’s how the ECB’s QE rules work. That 33 percent cap is a cap based on the total bonds issued by a eurozone member state, so if Portugal finds itself in a situation where it can’t tap the bond markets as much as it would like to do, it can’t tap that QE as much either. And there aren’t actually a lot options for the ECB of Portugal either thanks to the insane self-imposed ECB QE rules:

    Bloomberg Markets

    Portugal Bonds Falter as ECB Running Out of Eligible Debt to Buy

    * Continued deviation from ECB bond-buying rules looks likely
    * Bond yields have climbed as market wakes up to lower demand

    by Stephen Spratt
    January 16, 2017, 7:28 AM CST

    The European Central Bank is running out of Portuguese bonds to buy.

    The central bank’s holdings of Portugal’s debt are already pushing the limit set by its own guidelines, leaving it likely to buy less this year to avoid breaking those rules. That prospect has led to a selloff in Portuguese government bonds, with 10-year yields having risen almost 40 basis points since the ECB’s December meeting to hit an 11-month high last week.

    The ECB will have to scale back Portuguese purchases by around a half, according to Commerzbank AG, while ABN AMRO Group NV sees it stopping or suspending them by June. To make up the shortfall, the ECB may continue to buy more bonds from other countries with a greater pool of eligible securities, such as Germany and France.

    “We remain cautious on PGBs overall,” said Bank of America Merrill Lynch analysts including Ruairi Hourihane in a report on Jan. 13. “The QE tweaks announced in December benefited core countries far more than Portugal and the periphery. In fact, the new QE parameters made the continuation of QE in Portugal slightly more difficult.”

    ““We remain cautious on PGBs overall,” said Bank of America Merrill Lynch analysts including Ruairi Hourihane in a report on Jan. 13. “The QE tweaks announced in December benefited core countries far more than Portugal and the periphery. In fact, the new QE parameters made the continuation of QE in Portugal slightly more difficult.”

    Yep, the ECB’s December 8th tweaks to the QE program made things better for the eurozone core and worse for the periphery. And a month later we find Portugal facing spiking borrowing costs with the possibility that it will hit the 33 percent cap by June and get effectively suspended from the QE program. What helpful tweaks.

    And what might the ECB do in response to this latest eurozone crisis flare up?


    The ECB will have to scale back Portuguese purchases by around a half, according to Commerzbank AG, while ABN AMRO Group NV sees it stopping or suspending them by June. To make up the shortfall, the ECB may continue to buy more bonds from other countries with a greater pool of eligible securities, such as Germany and France.

    Buy more French and German bonds because that won’t break the QE rules.

    Yes, things are heating up in the Portuguese bond markets as the eurozone social contract continues to cool off.

    Posted by Pterrafractyl | January 18, 2017, 11:45 pm
  5. Donald Trump’s economic adviser, Peter Navarro, had a rather interesting explanation for why the US wasn’t going to be moving forward with TTIP trade agreement with the EU: Germany’s participation in the eurozone effectively made Germany a currency manipulator since the euro is much cheaper than a Deutsche Mark would have been. Amazingly for the Trump team, it wasn’t an entirely invalid point.

    Berlin, not surprisingly, didn’t agree with Navarro’s assertions, replying that Germany can’t control the ECB and its quantitative easing programs that are driving down the value of the euro so it’s not Germany’s fault that the euro is so cheap. And while that’s a rather debatable suggestion from Berlin (it ignores the role Berlin’s austerity demands and refusal to set up a transfer union have played in creating the enduring economic collapse of much of Europe), it’s also a response to a different charge than the one Navarro was making:

    The Financial Times

    Trump’s top trade adviser accuses Germany of currency exploitation

    Berlin is using a ‘grossly undervalued’ euro to gain advantage over trading partners, says Navarro

    by: Shawn Donnan in Washington
    1/31/2017

    Germany is using a “grossly undervalued” euro to “exploit” the US and its EU partners, Donald Trump’s top trade adviser has said in comments likely to trigger alarm in Europe’s largest economy.

    Peter Navarro, the head of Mr Trump’s new National Trade Council, told the Financial Times the euro was like an “implicit Deutsche Mark” whose low valuation gave Germany an advantage over its main trading partners. His views suggest the new administration is focusing on currency as part of its hard-charging approach on trade ties.

    In a departure from past US policy, Mr Navarro also called Germany one of the main hurdles to a US trade deal with the EU and declared talks with the bloc over a US-EU agreement, known as the Transatlantic Trade and Investment Partnership, dead.

    Angela Merkel, the German chancellor, responded to Mr Navarro’s allegations, saying Germany could not influence the euro. At a press conference in Stockholm with Stefan Lofven, Sweden’s prime minister, Ms Merkel said Germany has always “supported an independent European Central Bank”.

    The new president says he prefers bilateral trade deals rather than the broad multilateral accords pursued by Barack Obama, his predecessor. Mr Trump last week also withdrew from a 12-country Pacific Rim deal negotiated by Mr Obama.

    “A big obstacle to viewing TTIP as a bilateral deal is Germany, which continues to exploit other countries in the EU as well as the US with an ‘implicit Deutsche Mark’ that is grossly undervalued,” Mr Navarro said. “The German structural imbalance in trade with the rest of the EU and the US underscores the economic heterogeneity [diversity] within the EU — ergo, this is a multilateral deal in bilateral dress.”

    Germany’s large trade surplus with the US and much of the eurozone has been a point of friction in Brussels and Washington for several years, with both capitals calling for Berlin to stimulate domestic demand to rebalance its economy.

    Critics have argued Berlin has disproportionally benefited from weakness in the rest of the eurozone, which has held the euro lower than other regional currencies, like the Swiss Franc, making German exports cheaper in overseas markets like China and the US.

    Despite those differences, most debate over German economic policy during the Obama administration was cloaked in diplomatic language; Mr Navarro’s comments highlight a growing willingness by the Trump administration to antagonise EU leaders and particularly the German chancellor.

    Besides publicly supporting the British government in its negotiations with the EU over the terms of its exit, Mr Trump called the EU a vehicle for Germany, and Nato an obsolete alliance.

    Mr Navarro’s intervention follows a visit to Washington last week by Theresa May, the British prime minister, in which she and Mr Trump discussed ways to launch negotiations for a US-UK trade deal. Mr Navarro said the Brexit vote marked the death knell of a US-EU deal; Britain had been one of the pact’s leading advocates.

    “Brexit killed TTIP on both sides of the Atlantic even before the election of Donald Trump. I personally view TTIP as a multilateral deal with many countries under one ‘roof’,” Mr Navarro wrote in emailed responses to FT questions.

    Although criticisms of German economic policy have been a staple of Group of 20 gathering since the height of the eurozone crisis, the view Berlin is intentionally advocating a weak euro to its own economic benefit is not widely shared.

    The euro has weakened against the dollar over the past two years as the paths of the central banks of the two currency zones have split. The European Central Bank’s mass bond-buying programme has weakened the single currency, while rate hikes by the US Fed has strengthened the dollar.

    But Berlin has been a leading critic of the ECB’s strategy. The Bundesbank has called for an end to bond buying, while lawmakers have pushed for higher rates — both measures which would strengthen the euro.

    Mr Navarro said one of the administration’s trade priorities was unwinding and repatriating the international supply chains on which many US multinational companies rely, taking aim at one of the pillars of the modern global economy.

    ““A big obstacle to viewing TTIP as a bilateral deal is Germany, which continues to exploit other countries in the EU as well as the US with an ‘implicit Deutsche Mark’ that is grossly undervalued,” Mr Navarro said. “The German structural imbalance in trade with the rest of the EU and the US underscores the economic heterogeneity [diversity] within the EU — ergo, this is a multilateral deal in bilateral dress.””

    It’s hard to argue with the idea of a systematically undervalued Deutsche Mark since that’s the only thing that could have mathematically happened when one of the strongest currencies on the planet got pooled with a bunch of weaker ones. But there is one way to argue with it: hear a different point instead – like the point that Germany was forcing the euro overall to get too cheap – and respond to that one, which is what Angela Merkel clearly did:

    Angela Merkel, the German chancellor, responded to Mr Navarro’s allegations, saying Germany could not influence the euro. At a press conference in Stockholm with Stefan Lofven, Sweden’s prime minister, Ms Merkel said Germany has always “supported an independent European Central Bank”.

    So that’s how this strange tussle between Trump and Germany played out: Team Trump made a rare valid point (the euro replacement for the Deutsche Mark makes Germany’s current too cheap), and that point got misconstrued as a complete different point that Angela Merkel then responded to (that Germany is making the euro too cheap to which Merkel replied, no, Germany doesn’t set ECB policy). But while it’s clear that there was a lack of clarity in how Navarro’s assertions were interpreted, it’s still very unclear how this tussle is going to play out in the long-run. Because this topic presumably isn’t going to go away entirely. Especially since the way most of the press and people in general appeared to interpret Navarro’s point was the way Angela Merkel decided to misinterpret it:

    Slate

    Trump’s Trade Guru Just Trashed Germany. He Actually Had a Point!

    By Jordan Weissmann
    Jan. 31 2017 6:37 PM

    Peter Navarro, Donald Trump’s White House trade guru, typically reserves his harshest rhetoric for China. But Tuesday, the economist managed to cause a bit of an international stir by laying into Germany, which he accused of exploiting the United States and its fellow European Union members with the help of a “grossly undervalued” currency.

    He wasn’t all wrong.

    Navarro made his comments in an email interview with the Financial Times, which seemingly wanted to know his thought on the Transatlantic Trade and Investment Partnership, aka the big free-trade deal between the U.S. and the EU. Navarro was not encouraging about it. As a rule, the administration plans to pursue bilateral trade deals, not big multilateral trade agreements that rope in lots of different countries. And even though the EU is a unified trade bloc, Navarro doesn’t feel like a pact with all of its members would pass the White House’s test. Why not? In part, Berlin.

    The global reaction was not exactly kind. The FT itself haughtily explained that “the view Berlin is intentionally advocating a weak euro to its own economic benefit is not widely shared.” Asked about the remarks, German Chancellor Angela Merkel essentially shrugged and suggested there wasn’t much her country could do to influence the euro’s exchange rate, because it didn’t control the EU’s monetary policy. “We won’t exercise any influence over the European Central Bank, so I can’t and I don’t want to change the situation as it is now,” Merkel said. Analysts were also dismissive of Navarro. “He hasn’t understood the euro or this is a serious conspiracy accusation,” Henrik Enderlein, director of the Jacques Delors Institut in Berlin, told the Telegraph.

    But all of this sort of missed the point. Based on his quote, Navarro wasn’t necessarily saying the euro was too cheap across the board. Instead, he was merely saying it was too cheap for Germany. This is something virtually everyone agrees on, except for maybe the Germans themselves. Were the deutsche mark still around, Germany’s massive trade surplus, which as a percentage of its economy is actually larger than China’s, would have forced up the value of its currency, leading it to import more and export less. Instead, Germany is locked into a trade and currency union with a group of economically weaker countries who keep the value of the euro down, which makes it easier for factories in Wolfsburg and Munich and Bremen to sell their wares both inside and outside Europe.

    This really isn’t controversial. Even Former Fed Chairman Ben Bernanke had a whole spiel about this a couple years ago. “Although the euro—the currency that Germany shares with 18 other countries—may (or may not) be at the right level for all 19 euro-zone countries as a group, it is too weak (given German wages and production costs) to be consistent with balanced German trade.”

    There’s also plenty Germany could do to fix its trade imbalance, but isn’t. One reason it has such a large surplus from exports is that the country has an exceedingly high national savings rate—basically, Germans and their government don’t spend enough. As Bernanke suggested, Berlin could dabble more in budget deficits to rev up its economy, or take action to increase workers’ wages, both of which might lead to more imports. Alternatively, it could encourage more investment spending by corporations.

    The status quo, though, really isn’t healthy. Massive trade imbalances are not good for the global economy in the long term. Surplus countries find themselves with giant pools of savings they need to invest, which can create bubbles and financial crises. In Europe, it led cash-flush German bankscash to lend excessively to debtor nations like Greece that weren’t able to pay it back. The ensuing crises, of course, led Germany and its northern neighbors to enforce painful austerity programs that helped spread mass unemployment across the continent. No one wants a repeat of that.

    That isn’t to say Navarro’s concerns are entirely on point. The idea that Germany might be stealing a significant number of American jobs these days is a bit far-fetched. But refusing to sign a trade pact with Europe at large unless Germany becomes a more responsible actor isn’t really nuts. In fact, if the message were coming from any other administration, it might serve as a necessary wake-up call.

    When a Trumpkin is right, they’re right.

    The global reaction was not exactly kind. The FT itself haughtily explained that “the view Berlin is intentionally advocating a weak euro to its own economic benefit is not widely shared.” Asked about the remarks, German Chancellor Angela Merkel essentially shrugged and suggested there wasn’t much her country could do to influence the euro’s exchange rate, because it didn’t control the EU’s monetary policy. “We won’t exercise any influence over the European Central Bank, so I can’t and I don’t want to change the situation as it is now,” Merkel said. Analysts were also dismissive of Navarro. “He hasn’t understood the euro or this is a serious conspiracy accusation,” Henrik Enderlein, director of the Jacques Delors Institut in Berlin, told the Telegraph

    Yep, even the original FT article was interpreting Navarro’s comments as indicating that it was a critique against the low level of the euro as opposed to the disproportionate impact the low level of the euro has on Germany’s exports. Along with plenty of other commentators and analysts. And while this might seem like just a random example of a frustrating media confusion, keep in mind that having Team Trump complain about an overly weak euro (as opposed to an overly weak euro replacement for the Deutsche Mark) is exactly what Germany’s hardliners want! Because perceived US pressures on the eurozone to raise the value of the euro are basically a US call to do something Germany’s right-wing has been calling for all along: end the ECB’s quantitative easing program:

    The New York Times
    The Conscience of a Liberal

    Germany, the Euro, and Currency Manipulation

    Paul Krugman
    February 1, 2017 12:49 pm

    Peter Navarro, the closest thing Trump has to an economic guru, made some waves by accusing Germany of being a currency manipulator and suggesting that both the shadow Deutsche mark and the euro are undervalued. Leaving aside the dubious notion that this is a good target of US economic diplomacy, is he right?

    Yes and no. Unfortunately, the “no” part is what’s relevant to the US.

    Yes, Germany in effect has an undervalued currency relative to what it would have without the euro. The figure shows German prices (GDP deflator) relative to Spain (which I take to represent Southern Europe in general) since the euro was created. There was a large real depreciation during the euro’s good years, when Spain had massive capital inflows and an inflationary boom. This has only been partly reversed, despite an incredible depression in Spain. Why? Because wages are downward sticky, and Germany has refused to support the kind of monetary and fiscal stimulus that would raise overall euro area inflation, which remains stuck at far too low a level.

    So the euro system has kept Germany undervalued, on a sustained basis, against its neighbors.

    But does this mean that the euro as a whole is undervalued against the dollar? Probably not. The euro is weak because investors see poor investment opportunities in Europe, to an important extent because of bad demography, and better opportunities in the U.S.. The travails of the euro system may add to poor European perceptions. But there’s no clear relationship between the problems of Germany’s role within the euro and questions of the relationship between the euro and other currencies.

    And may I say, what is the purpose of having someone connected to the U.S. government say this? Are we going to pressure the ECB to adopt tighter monetary policy? I sure hope not. Are we egging on a breakup of the euro? It sure sounds like it — but that is not, not, something the US government should be doing. What would we say if Chinese officials seemed to be talking up a US financial crisis? (It would, of course, be OK with Trump if the Russians did it.)

    And may I say, what is the purpose of having someone connected to the U.S. government say this? Are we going to pressure the ECB to adopt tighter monetary policy? I sure hope not. Are we egging on a breakup of the euro? It sure sounds like it — but that is not, not, something the US government should be doing. What would we say if Chinese officials seemed to be talking up a US financial crisis? (It would, of course, be OK with Trump if the Russians did it.)”

    And that’s the big question here: Are we about to see the Trump administration use a fight with Germany to help pressure the eurozone into adopting a policy – end the ECB’s QE program – that Germany’s right-wing has been clamoring for ever since the ECB started it? Because whether or not that was Navarro’s intent, that’s how it’s playing out:

    The Wall Street Journal

    Draghi: Not Yet Time to Stop European Stimulus
    ECB president cautions against relying too heavily on recent economic indicators

    By Tom Fairless and Todd Buell
    Updated Feb. 6, 2017 2:38 p.m. ET

    European Central Bank President Mario Draghi said Monday it is too early to start winding down the bank’s bond purchases, brushing off fresh criticism of the program in Germany as inflation has picked up.

    In a hearing at the European Parliament in Brussels, Mr. Draghi highlighted recent improvements in the eurozone’s €10 trillion ($10.8 trillion) economy, including declining unemployment. But he said policy makers wouldn’t overreact to a recent rise in inflation, which he attributed to higher energy prices.

    The ECB decided in December to expand its so-called quantitative-easing programs by a half-trillion euros, through the end of this year. The move has triggered fresh criticism of the central bank in Germany, Europe’s largest economy, and sparked a rare public spat between senior German and U.S. officials.

    In Germany, the recent rise in inflation has fueled criticism of the ECB’s low interest rates, which opponents have blamed for harming the region’s savers.

    In the U.S.—where the Federal Reserve has started to raise interest rates—Peter Navarro, the head of President Donald Trump’s National Trade Council, last week told the Financial Times that Germany is benefiting from a “grossly undervalued” euro that gives the nation an unfair edge over its trading partners.

    German Finance Minister Wolfgang Schäuble—who has sparred verbally with Mr. Draghi in the past—responded to the U.S. criticism, laying the blame for Germany’s giant trade surpluses at the ECB’s door.

    “When ECB chief Mario Draghi embarked on the easy-money policies, I told him that he would drive up the German trade surplus,” Mr. Schäuble told a German newspaper over the weekend. “I don’t want to be criticized for the consequences of these policies.”

    At Monday’s hearing, Mr. Draghi sought to diffuse the dispute. He argued that different central-bank policies reflected “diverse positions in the [economic] cycle” between the U.S. and the eurozone.

    “We are not currency manipulators,” Mr. Draghi said. Germany’s trade surpluses, he said, reflect the nation’s strong productivity, not wage manipulation. He highlighted a recent U.S. Treasury Department report to Congress that absolved Germany of currency manipulation.

    One European lawmaker said Monday that the ECB chief was a “favorite scapegoat for Mr. Schäuble.” A year ago, the German finance minister blamed Mr. Draghi for the rise of a populist political party, the Alternative for Germany, which has been critical of the ECB.

    Mr. Draghi declined to respond directly to the finance minister’s criticism.

    “It’s understandable that politicians, especially in times of elections, express views on monetary policy,” Mr. Draghi said. But also is understandable that central bankers “hear them, but don’t listen,” he said.

    Pressed on when the ECB might start to wind down its bond purchases, Mr. Draghi said it would only consider doing so when inflation rises across the region in a durable way. The ECB might even step up its stimulus measures if economic conditions deteriorate, he said.

    Some lawmakers had hoped for more clarity. “The question of how to deal with quantitative easing is the elephant in the room,” said Markus Ferber, a German lawmaker who is vice chairman of the European Parliament’s economic and monetary affairs committee. “I would definitely like the ECB’s president to address the issue rather sooner than later.”

    Mr. Draghi faced a series of questions about the actions of the new Trump administration, including efforts last week to start scaling back Dodd-Frank financial regulations.

    Such a move, Mr. Draghi warned, could set the stage for another financial crisis. “A combination of easy money and financial deregulation was exactly the ground upon which the financial crisis developed,” he said. “Frankly, I don’t see any reason to relax the present regulatory stance.”

    “At Monday’s hearing, Mr. Draghi sought to diffuse the dispute. He argued that different central-bank policies reflected “diverse positions in the [economic] cycle” between the U.S. and the eurozone.”

    So a week after one of Trump’s economic advisors makes this argument about how Germany’s participation in the euro effectively acts like currency manipulation and the point gets immediately interpreted as a different point about the low value of the euro in general, we still have the head of the ECB answering questions in a public hearing as if Navarro’s point was about the low value of the euro in general. And no apparent clarification from Team Trump on what precise point Navarro was trying to make. And who knows, he probably wanted to make both points.

    So, intentionally or unintentionally, it looks like Team Trump is joining Team Strong Euro/Team End-QE and pushing for a premature end to the ECB’s QE program and sharp rise in the euro, which is exactly what Berlin’s conservatives want to see happen. And they did it by attacking Germany. *golf clap*

    Posted by Pterrafractyl | February 6, 2017, 9:29 pm
  6. Oh look at that: Portugal’s left-wing anti-austerity government that was causing so much fear in Brussels and Berlin last year (and almost got fined for government overspending due to those fears) just reported the lowest budget deficit in four decades in 2016:

    Associated Press

    Portugal cuts budget deficit to lowest level in 4 decades

    February 15

    LISBON, Portugal — Portugal’s government has proved its critics wrong, slashing the debt-heavy country’s budget deficit to its lowest level in more than 40 years despite warnings that its anti-austerity policies could spell financial disaster.

    Finance Minister Mario Centeno said Wednesday the deficit last year was no higher than 2.1 percent — well within the 2.5 percent ceiling stipulated by European authorities.

    Some other eurozone countries expressed alarm when the center-left Socialist government, with the support of the Communist Party and Left Bloc, took power in 2015 on an anti-austerity platform.

    Portugal needed a 78-billion euro ($82 billion) bailout in 2011, after recording a deficit of more than 11 percent the previous year, and eurozone officials feared it could go into another debt spiral under the Socialists.

    “Some other eurozone countries expressed alarm when the center-left Socialist government, with the support of the Communist Party and Left Bloc, took power in 2015 on an anti-austerity platform.”

    Why, it’s almost as if the EU’s austerity fetish was a horrible idea all along. A predictably horrible disaster. Hopefully examples like Portugal’s anti-austerity success will one day lead to a Europe where we should no longer predict predictably bad austerity policies. Although if the latest study on the impact of austerity is correct, we probably shouldn’t assume that more examples of the poor results of austerity are going to change future behavior since economists have known for decades that austerity in the wake of a massive crisis and near-zero interest rates was a really bad idea, and they went ahead with it anyway. Because it’s also a great excuse to implement right-wing cuts to government:

    The Washington Post

    Austerity was a bigger disaster than we thought

    By Matt O’Brien
    February 15, 2017

    We now take a break from your regularly scheduled scandals to bring you some not-so-breaking news: austerity was as big a disaster as its biggest critics said it was.

    That, at least, is what economists Christopher House and Linda Tesar of the University of Michigan and Christïan Proebsting of the École Polytechnique Fédérale de Lausanne found when they looked at Europe’s budget-cutting experience the last eight years. It turns out that cutting spending right after the worst crisis in 80 years only led to a lower gross domestic product and, in the most extreme cases, higher debt-to-GDP ratios. That’s right: trying to reduce debt levels sometimes increased debt burdens.

    But let’s back up a minute. This isn’t something that’s always true. In fact, it almost never used to be. Cutting spending, you see, shouldn’t be a problem as long as you can cut interest rates too. That’s because lower borrowing costs can stimulate the economy just as much as lower government spending slows it down. What happens, though, if interest rates are already zero, or, even worse, you’re part of a currency union that means you can’t devalue your way out of trouble?

    Well, nothing good. House, Tesar and Proebsting calculated how much each European economy grew — or, more to the point, shrank — between the time they started cutting their budgets in 2010 and the end of 2014, and then compared it with what actually realistic models say would have happened if they hadn’t done austerity or adopted the euro. According to this, the hardest-hit countries of Greece, Ireland, Italy, Portugal and Spain would have contracted by only 1 percent instead of the 18 percent they did if they hadn’t slashed spending; by only 7 percent if they’d kept their drachmas, pounds, liras, escudos, pesetas and the ability to devalue that went along with them if they hadn’t become a part of the common currency and outsourced those decisions to Frankfurt; and only would have seen their debt-to-GDP ratios rise by eight percentage points instead of the 16 they did if they hadn’t tried to get their budgets closer to being balanced. In short, austerity hurt what it was supposed to help, and helped hurt the economy even more than a once-in-three-generations crisis already had.

    That brings us to two final points. The first is that the euro really has been a doomsday device for turning recessions into depressions. It’s not just that it caused the crisis by keeping money too loose for Greece and the rest of them during the boom and too tight for them during the bust. It’s also that it forced a lot of this austerity on them.

    Think about it like this. Countries that can print their own money never have to default on their debts — they can always inflate them away instead — but ones that can’t, because, say, they share a common currency, might have to. Just the possibility of that, though, can be enough to make it a reality. If markets are worried that you might not be able to pay back your debts, they’ll make you pay a higher interest rate on them — which might make it so that you really can’t.

    In other words, the euro can cause a self-fulfilling prophecy where countries can’t afford to spend any more even though spending any less will only make everything worse. That’s actually a pretty good description of what happened until the European Central Bank belatedly announced that it would do “whatever it takes” to put an end to this in 2012. Which was enough to get investors to stop pushing austerity, but, alas, not politicians.

    It’s a good reminder that you should never doubt that a small group of committed ideologues can destroy the economy. Indeed, it’s the only thing that ever has.

    That’s true whether you’re talking about the European politicians who pushed for the creation of the euro itself — they ignored the economists who warned them that it might turn out just as badly as it has — or the ones who pushed for austerity a few decades later. After all, it shouldn’t have been a surprise that trying to balance your budget when interest rates were zero would end badly.

    Economists have known that since the 1930s. Politicians, though, still wanted to do it, either because they thought deficits were morally, politically, or economically bad, and there was no shortage of supposed experts who were willing to tell them that they were right.

    These right-wing economists produced study after study showing that countries had been able to successfully cut spending when central banks could offset that by cutting interest rates, and said that this proved that the same was true when interest rates were zero like they were at the time.

    You didn’t need an economics PhD to know this didn’t make sense, just a basic knowledge of economic history.

    But no matter. Economists who had never bothered to learn this, or who had forgotten it, or who especially saw this as a good excuse to cut government spending they’d always wanted to kept saying it would work even as it kept failing.

    That should be as big a scandal as anything else.

    “That brings us to two final points. The first is that the euro really has been a doomsday device for turning recessions into depressions. It’s not just that it caused the crisis by keeping money too loose for Greece and the rest of them during the boom and too tight for them during the bust. It’s also that it forced a lot of this austerity on them.”

    Yep, while the euro acts as a nice stabilizer for stronger countries like Germany, for the periphery nations like Portugal the euro causes bigger booms and bigger busts. And resulting mandatory austerity guaranteed an in even bigger crisis that could be used to justify even bigger cuts to government spending:

    Well, nothing good. House, Tesar and Proebsting calculated how much each European economy grew — or, more to the point, shrank — between the time they started cutting their budgets in 2010 and the end of 2014, and then compared it with what actually realistic models say would have happened if they hadn’t done austerity or adopted the euro. According to this, the hardest-hit countries of Greece, Ireland, Italy, Portugal and Spain would have contracted by only 1 percent instead of the 18 percent they did if they hadn’t slashed spending; by only 7 percent if they’d kept their drachmas, pounds, liras, escudos, pesetas and the ability to devalue that went along with them if they hadn’t become a part of the common currency and outsourced those decisions to Frankfurt; and only would have seen their debt-to-GDP ratios rise by eight percentage points instead of the 16 they did if they hadn’t tried to get their budgets closer to being balanced. In short, austerity hurt what it was supposed to help, and helped hurt the economy even more than a once-in-three-generations crisis already had.

    Austerity was an across the board failure. At least economically speaking. It could only be considered a success if gutting the government is the goal. Which was pretty much the case:


    These right-wing economists produced study after study showing that countries had been able to successfully cut spending when central banks could offset that by cutting interest rates, and said that this proved that the same was true when interest rates were zero like they were at the time.

    You didn’t need an economics PhD to know this didn’t make sense, just a basic knowledge of economic history.

    But no matter. Economists who had never bothered to learn this, or who had forgotten it, or who especially saw this as a good excuse to cut government spending they’d always wanted to kept saying it would work even as it kept failing.

    That should be as big a scandal as anything else.

    Yep, it should all be a pretty massive scandal. But isn’t. Which is, of course, pretty scandalous.

    Posted by Pterrafractyl | February 20, 2017, 9:01 pm

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