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The New World Ordoliberalism, Part 7: To QE, or Not to QE, That is the Ominous Question

As the European Central Bank (ECB) continues to wrestle with the decision of when and how quickly to wind down its quantitative easing (QE) program while inflation remains stubbornly below the 2 percent target and likely to stay well below 2 percent for the foreseeable future, it’s worth noting that there’s a new nightmare to add to the equation: The euro has surged in value this year, a move that not only depresses exports in recovery economies like Spain and Portugal but also depresses inflation. And one of the things holding down the value of the euro is the ECB’s QE program. So if the ECB tapers off the QE too early and quickly it’s going to make an overly-strong euro even stronger while dragging inflation even lower, potentially derailing fragile recoveries in the austerity-inflicted member states.

Adding to the ECB’s challenges is that the QE program officially expires at the end of 2017. Unless it’s extended. And as the following article notes, when you look at the schedule for the ECB’s Governing Council meetings where the upcoming QE details – with a meeting on October 26th and another on December 14th – it’s entirely possible that the ECB won’t finalize its QE details until that December 14th meeting. And if that happens, markets are only going have around 10 trading days to adjust to whatever the new QE reality is going to be going forward. And those trading days at the end of year tend to be low volume and therefore potentially much more volatile. So if there’s a big surprise, and it’s a negative surprise from the market’s perspective, we could see some wild times for the eurozone’s financial markets heading into the New Year and a wild time for the eurozone economies next year. Wild unpleasant times.

But even if the ECB does manage to make it very clear what it’s planning for the QE program well in advance of that December 14th meeting, if that decision involves a premature curtailment of the QE program that could still results in an ongoing surge in the value of the euro and further flirtations with deflation. And more wild unpleasant times for the eurozone as a surging euro starts killing off the fragile export-driven recoveries of in places like Spain, Greece, and Portugal.

And as we saw in Part 6 of this series [1], there’s also the ongoing issue of the QE “capital keys” that determine the volume of bonds each eurozone nation’s central bank can legally purchase without breaking the ECB’s self-imposed QE rules. In the case of Germany, which has the largest round monthly bond purchases due to the large size of the German economy, there is simply a lack of enough available bonds. But for the weaker nations like Portugal and Ireland the “capital key” cap on the amount of bonds the ECB can purchase in the QE program poses a different kind of limitation: the “cap” on the the total size of that nation’s bond market (33 percent of the total national sovereign bond market) that can be bought up in the QE program is already being hit in Portugal and Ireland and it’s going to be hit in other member states the longer QE continues, potentially forcing a premature ending to QE unless whether that’s prudent or not.

Sure, the ECB simply could change the rules that limit the available bonds to get around this limitation, but that probably won’t be an option with the Bundesbank and its allies completely opposed to the idea. And that means that we are looking at a situation where:
1. The ECB clearly wants to end QE as soon as the economic situation allows for it.

2. The rising value of the euro is making ending QE a lot less feasible at the moment because ending QE is inevitably going to make the euro rise even more and that threatens the export-led recoveries of the eurozone member states that were forced to incurred massive austerity in order to cut costs and make their economies more export-oriented.

3. Even if QE is extended significantly, unless there’s a rule change to the 33 percent cap rule there’s going to be an end to QE anyway, hitting one nation at a time as they approach that cap.

And that all means we’re in a situation where the political drive to end QE shows no signs of abating while the signals from the actual economy (persistently low inflation, fragile recoveries, and a surging euro that threatens those fragile recoveries) are increasingly warning against a hasty and ill-timed QE taper. And the ECB has to decide what it’s going to do before the end of 2017, but it can’t wait too long to make that decision because markets need time to adapt without creating turmoil in the financial markets.

As is the case with so much of the ECB’s decisions since the start of the eurozone financial crisis the suspense is tinglingly terrifying [2]:

Bloomberg Markets

ECB May Not Have Final QE Plan Ready Until December

* Officials may not finalize new bond plan until December
* Traders would only have about 10 trading days to adapt

By Paul Gordon and Lucy Meakin
September 1, 2017, 7:40 AM CDT September 1, 2017, 12:02 PM CDT

The European Central Bank has a tight timetable for deciding the future of its bond-buying program, but investors may face an even tighter one to adjust to the outcome.

The Governing Council will hold its first formal talks next week on the pace of asset purchases after December, when the current program is scheduled to expire. Yet it’s conceivable that the decision won’t be finalized until the Dec. 14 meeting, according to euro-area officials familiar with the matter. That would leave around 10 trading days, during a holiday season when volumes are typically low, for market participants to sort out their strategy for the New Year.

The ECB’s 25 policy makers have plenty to talk about: some say the euro area’s robust economic recovery warrants the winding down of bond purchases — currently running at 60 billion euros ($71 billion) a month — while others point to feeble inflation as a reason to keep stimulus going. Yet leaving a decision too late could unnerve investors and push up the euro and bond yields, undermining the efforts so far.

“We’re all aware of the reality of the clock that they face,” said Charles Diebel, head of rates at Aviva Investors in London. “But markets have got very used to being told what’s coming a long time in advance, so to chance your arm and decide to wing it at the last minute in itself is like asking for trouble.

Possible Signals

Officials are aware of the risk of waiting too long, with two of the people saying they shouldn’t surprise investors by holding back every detail on the future of QE until the final meeting of the year. That suggests the ECB is still likely to deliver signals on the plan for asset purchases after one or both of the next two meetings. A spokesman for the central bank declined to comment.

Neither would a tapering decision at two weeks notice be unprecedented. When the U.S. Federal Reserve decided to cut its own bond purchases starting in January 2014, it made the announcement on Dec. 18, 2013.

The difference is that the Fed started formal talks on tapering at their June 2013 meeting and frequently talked in public about tapering in the following months. The New York Fed even included questions on the topic in its survey of primary dealers.

The ECB has so far explicitly avoided putting the topic of next year’s purchases on the Governing Council’s agenda. At July’s session, it agreed to start discussions in “the fall,” but even then opted not to say if that necessarily meant the Sept. 7 meeting.

The slide in the euro in reaction to the news that the full details of the asset-purchase plan may wait until until December might encourage those policy makers who expressed concern at the July meeting of a possible overshoot of the single currency.

The euro’s gain after President Mario Draghi’s speech in Portugal in June — when he spoke of “reflationary forces” — and the currency’s jump again last week when he opted not to try to talk it down in a speech in Jackson Hole, Wyoming, showed how sensitive markets are. That justifies extreme prudence, with changes to communication and policy likely to move even slower than originally expected, two of the people said.

Economic Upturn

Some policy makers are more sanguine. Bundesbank President Jens Weidmann and Estonian central-bank governor Ardo Hansson have both said recently that the euro’s strength reflects the economy’s upturn and is nothing to worry about. Austrian Governor Ewald Nowotny said on Friday that he wouldn’t “dramatize” the gain.

But Nowotny also added that policy normalization can’t be about “abruptly stepping on the brake.” It’s “sensible to see how to get off the accelerator and how to carefully initiate” the process, he said. Vice President Vitor Constancio said in a separate speech that while the euro area’s economic recovery is proving to be increasingly robust, a “strong worldwide reflationary phase that seemed likely at the beginning of the year has not materialized.”

But for some commentators, the urgency for action is mounting because the ECB looks set to run into its self-imposed limits on how much debt it can buy from each nation, issuer and bond issue. The current schedule will take its purchases to 2.3 trillion euros, equivalent to almost a quarter of gross domestic product. The ECB’s balance sheet — fueled by free loans to banks — has soared to 4.3 trillion euros.

“Sticking your head in the sand until December and hoping the problem goes away is not a communication strategy,” said Richard Barwell, an economist at BNP Paribas Asset Management in London. “The issue limits are going to force them to exit prematurely. They cannot duck the consequences indefinitely.”

———-

“ECB May Not Have Final QE Plan Ready Until December” by Paul Gordon and Lucy Meakin; Bloomberg Markets; 09/01/2017 [2]

“The Governing Council will hold its first formal talks next week on the pace of asset purchases after December, when the current program is scheduled to expire. Yet it’s conceivable that the decision won’t be finalized until the Dec. 14 meeting, according to euro-area officials familiar with the matter. That would leave around 10 trading days, during a holiday season when volumes are typically low, for market participants to sort out their strategy for the New Year.”

Yeah, the end of the year at the last minute probably isn’t the best time for the ECB to throw a surprise QE curveball. Unless it’s a very accomodative curveball that leans towards the ‘dovish’ side that’s sort of a reiteration of the ECB’s long-held stance to “do whatever it takes” to hold the financial system together, the stance ECB Chief Mario Draghi historically took in 2012 as the eurozone sovereign bond markets teetered on the edge [3].

But if it’s a last minute negative curveball that tightens conditions and simultaneously signifies a historic pivot away from ‘do whatever it takes’ and sets market expectations for significant further tightening over the next year, things could get rather choppy:


“We’re all aware of the reality of the clock that they face,” said Charles Diebel, head of rates at Aviva Investors in London. “But markets have got very used to being told what’s coming a long time in advance, so to chance your arm and decide to wing it at the last minute in itself is like asking for trouble.

Shocking the markets out of QE complaceny does seem like asking for trouble. But sadly, we can’t entirely rule asking for trouble out. Because while Mario Draghi was reiterating his “Do whatever it takes” pledge to the markets over the past five years, we can’t forget that the Austerian wing [4] of the eurozone https://www.dailykos.com/stories/2012/05/14/1090839/-The-Austerions. For a lot of powerful people in the eurozone’s financial power structure – notably Bundesbank chief Jens Weidmann and German finance minister Wolfgang Schaeuble – calling for trouble is their thing. For the austerians, massive trouble for the nation isn’t a problem, it’s a solution.

Really stupid economic policies like the austerity madness was the ‘solution’ inflicted on Greece to a reprehensible degree [5] and to countries like Spain, Ireland, and Portugal to a somewhat less reprehensible degree. And the only reason that same far-right austerity agenda, an agenda that’s dominated most of the eurozone’s economic decision-making and successfully imposed austerity across Europe, hasn’t prevailed at the ECB level. And that’s because it would have imploded the entire eurozone economy and the zone itself. That’s too much trouble. But just about anything less than the implosion of the eurozone is apparently considered acceptable levels of trouble for Team Austerity. We’ve seen that over and over and there’s absolutely no indication that this has changed. Calls for trouble are very possible because they are very precedented.

Keeping the Market Uninformed isn’t the Best Policy, but Might not be as Bad as Informing the Market of Bad Policy

So hopefully the unspoken rule – the rule that national economies, but not the entire eurozone economy, can be allowed to implode – will continue ruling the day as the ECB approaches this big QE decision over the next few months. And hopefully the euro doesn’t keep surging too. But if the ECB really is going to wind down QE over the year or two it’s unclear what’s going to hold the euro down during the process. Maybe other measures will be used to hold the currency down, but the same forces that oppose QE all along have opposed all the other stimulative measures too. Will those forces be held at bay while QE unwinds? As we’re going to see, the answer to that question is “maybe?!”.

And let’s also not forget that the ECB’s need to signal to the the markets as early as possible of of its QE plans is potentially in conflict with the need to keep the value of euro down if the details of the ECB’s plans including ending QE soon too. If ending QE in 2018 really is the ECB’s plan, the euro probably has quite a bit of surging ahead of it unless something else intervenes. But the ECB can’t hold off on this decision for long. It has to finalize and release the details of its QE plans between now and its December 14th meeting at the very latest. And if those ECB plans really are plans to end QE, there’s real incentive for the ECB hold off on releasing those plans now in order to avoid the kind of euro surge that could disrupt those plans.

But waiting until the December 14th meeting also increases the odds of a bad market reaction. And the more the austerity faction wins out the worse that market reaction is going to be (worse, as in, a much higher euro). It’s a real conundrum. The ECB doesn’t just need to release its QE plan details soon. The ECB needs to release positive details that relieve the markets and avoid surging the euro. Soon (unless it’s ok with trouble, which is precedented) [6]:

CNBC

Euro zone countries could be in danger if euro continues to rise, economist says

The recent rise in the euro could put economic recovery in danger
“But if there would be an overshoot of the exchange rate then of course they’ll have a problem because with their large foreign debt they don’t have a second wheel on their machinery.”

Silvia Amaro
Published 4:45 AM ET Wed, 30 Aug 2017 | Updated 5:56 AM ET Wed, 30 Aug 2017

A euro that continues to rise against the U.S. dollar is now the main danger being posed to fragile euro zone economies that are still recovering after the sovereign debt crisis of 2011, one economist has told CNBC.

Ireland, Portugal and Spain have become some of the fastest growing economies in Europe after receiving help from creditors to restore their finances after the crises that begun in 2011. However, the recent rise in the euro could put their recoveries in danger, according to Daniel Gros, director of the think tank Centre for European Policy Studies, told CNBC Wednesday.

“That is of course the main danger point for them,” he said.

“As long as the euro doesn’t go much above 1.20 they should be able to continue. But if there would be an overshoot of the exchange rate then of course they’ll have a problem because with their large foreign debt they don’t have a second wheel on their machinery,” Gros said.

The euro rose above the 1.20 level against the greenback on Tuesday on growing geopolitical tensions between North Korea and the U.S. A stronger euro means that European products become more expensive in international markets, which could decrease foreign appetite for European goods and thus hurt EU economies.

Countries like Portugal and Spain owe much of their recovery to exports [7], exports have been higher than those of Germany, France and Italy (the biggest EU economies) since last year, according to data collected by TS Lombard.

John Hardy, head of forex trading at Saxo Bank, told CNBC Wednesday that “we have seen a near term peak of sorts triggered as the EURUSD and dollar Index breached key levels, but the pullback suggests the USD weakness has extended too far.”

The focus has started to shift towards Frankfurt where European Central Bank President Mario Draghi is due to speak next week, following a monetary policy meeting.

Investors had been hoping to get some indications about the bank’s program to exit monetary stimulus but the recent uptick in the euro raises doubts that the ECB will announce such details.

Easy monetary policy suppresses the value of a currency [8] and the potential end of this policy in the euro zone is seen as one of the key reasons why the euro is currently rising. A strong currency also acts as a deflationary pressure at a time when the central bank wants to bring core inflation up in the region.

In its latest forecasts, in June, the ECB projected headline inflation at 1.5 percent in 2017 and 1.3 percent in 2018. The bank’s target is to see inflation “close but below 2 percent.”

———-

“Euro zone countries could be in danger if euro continues to rise, economist says” by Silvia Amaro; CNBC; 08/30/2017 [6]

Easy monetary policy suppresses the value of a currency [8] and the potential end of this policy in the euro zone is seen as one of the key reasons why the euro is currently rising. A strong currency also acts as a deflationary pressure at a time when the central bank wants to bring core inflation up in the region.”

The markets are always watching. And they see a potential end to QE but they also see that a a rising euro is a predictable consequence of exactly that policy and also exactly the kind of change in circumstance that makes ending QE a lot harder. As a consequence, a week before the ECB’s September 7th meeting the markets could already see that the ECB’s expected ambitions were actively getting thwarted, in part thwarted by the rising euro resulting for those expected ambitions:


The focus has started to shift towards Frankfurt where European Central Bank President Mario Draghi is due to speak next week, following a monetary policy meeting.

Investors had been hoping to get some indications about the bank’s program to exit monetary stimulus but the recent uptick in the euro raises doubts that the ECB will announce such details.

So heading into the September 7th ECB meeting, the market’s were apparently expecting that the ECB wanted to announce an end QE, but the markets also recognized that attempting to an QE while the euro is surging is a highgly risky maneuver and might have to be postponed given current conditions. It’s sort of a Catch-22 situation, but not really. True Catch-22 situations don’t have an escape. In this case there is an escape – sane, sober policy – but sane, sober policy often isn’t an option for the ECB. It’s more like a synthetic Catch-22 situation created by the active decision to leave no good options.

Mario Draghi’s “No Decision Yet” September 7th Signal

What will the ECB ultimately do? Well, the ECB just met on Thursday, September 7th, and Mario Draghi did indeed give a signal. And it was quite a signal in an ironic sense: Draghi signaled that the volatility of the euro left the ECB uncertain about what to do with the QE. So he announced that they’re planning on making their decision in October, presumably at the ECB meeting on October 26th. He also signaled that inflation is expected to eventually reach 2 percent (what a bold prediction). Oh, and he noted that the QE discussions were very preliminary. And that they haven’t had any discussions at all about the “capital keys” caps on countries like Portugal that are preventing them from fully participating the QE [1] (the countries that need it the most get thwarted). He did state that interest rates were going to remain ultra-low for an extended period, but also noted that it hadn’t been discussed yet whether or not they’ll get raised before the QE program ends.

So the signal Draghi sent to the markets was that the ECB has no idea what it’s going to do, hasn’t really talked about it, and will decide in a month and a half (hopefully). And to placate the markets he also announced that interest rates will stay low for an extended period, although they haven’t decided yet whether to raise interest rates before or after QE is ended, which is a rather mixed signal since QE could end next year. But that’s the signal Draghi had to send. In terms of calming the markets and avoiding a further surging of the euro it probably wasn’t Draghi’s best signal to the markets [9]:

Bloomberg

Draghi Says Euro a Concern as ECB Targets October Decision on QE

* ECB cut its inflation outlook on surge in single currency
* Governors considered scenarios for recalibrating QE in 2018

By Carolynn Look
September 7, 2017, 8:00 AM CDT September 7, 2017, 8:35 AM CDT

Mario Draghi said the European Central Bank is watching the euro’s gains as policy makers edge toward settling the future of their bond-buying program.

“The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring” for its impact on price stability, the ECB president told reporters in Frankfurt on Thursday. He said the decisions on QE are “many, complex, and always naturally one thinks about risks that may materialize in the coming weeks or months, so that is the caution behind not specifying a date — probably the bulk of these decisions will be taken in October.”.=

The single currency rose as much as 1.2 percent as Draghi spoke to break above $1.20. It was up 0.9 percent at $1.2025 at 3:23 p.m. Frankfurt time.

The signal that a decision on bond purchases is likely next month “makes it difficult for the ECB president to talk down the euro,” said Nick Kounis, an economist at ABN Amro in Amsterdam. “The currency market is telling Draghi that talk is cheap and it is putting more weight on the upcoming QE actions.”

The euro’s surge — more than 14 percent against the dollar this year and almost 6 percent on a trade-weighted basis — was reflected in a downgrade to the ECB’s inflation outlook even as Draghi said economic growth remains solid. That highlights the difficulty policy makers face as they debate the future of their QE program — which has already topped 2 trillion euros ($2.4 trillion) and is scheduled to continue at a monthly pace of 60 billion euros until the end of this year.

ECB staff now see inflation at 1.2 percent in 2018 and 1.5 percent in 2019, well below the goal of just below 2 percent.

Still, Draghi said that there was “broad satisfaction” within the Governing Council that consumer prices will eventually converge with expectations for stronger growth.

The ECB chief described the discussion on the path of QE as “very, very preliminary” and that the Governing Council considered the “trade-offs” between various scenarios related to the pace and duration of purchases. Policy makers want to see the work of ECB’s technical committees before deciding, he said.

He said officials did not discuss the ECB’s self-imposed limits on the proportion of bond issues it can buy, not did they talk much about the risk the central bank will run out of debt to buy.

“We haven’t discussed really the scarcity issue because so far, he said. “We’ve consistently shown that we’ve been able to cope with this issue quite successfully.”

The ECB chief also reiterated that interest rates will be kept low for an extended period, and said officials did not discuss whether they could be raised before net asset purchases end.

———-
“Draghi Says Euro a Concern as ECB Targets October Decision on QE” by Carolynn Look; Bloomberg; 09/07/2017 [9]

““The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring” for its impact on price stability, the ECB president told reporters in Frankfurt on Thursday. He said the decisions on QE are “many, complex, and always naturally one thinks about risks that may materialize in the coming weeks or months, so that is the caution behind not specifying a date — probably the bulk of these decisions will be taken in October.”

The ECB punts the QE decision from its September 7th meeting to the October 26th meeting. Six weeks. And until then the signal to the markets from the ECB is likely going to be that it hasn’t decided yet. And that’s assuming the final decision really is made and announced by that October 26th meeting. And if things get pushed back to the December 14th meeting that leaves just 10 trading days before the end of the year. It’s going to be an interesting ride for the euro in the final quarter of 2017.

And don’t forget, the higher the euro goes, the closer inflation gets to that deflationary danger zone. A danger zone the eurozone is already scheduled to flirt with over the next couple of years (hence Draghi’s expectation that inflation will “eventually” converge with the 2 percent target):


ECB staff now see inflation at 1.2 percent in 2018 and 1.5 percent in 2019, well below the goal of just below 2 percent.

Still, Draghi said that there was “broad satisfaction” within the Governing Council that consumer prices will eventually converge with expectations for stronger growth.

But also don’t forget that there are things Draghi could easily say that will bring the euro down. He could tell the markets good news that reassures it that the ECB is committed to its existing accommodative policies and a smooth landing for the QE and not some arbitrarily set deadline to placate the Ordoliberal faction’s ideological desire to end stimulative measures [10]. Policy sanity. That would help bring down the euro. But it’s apparently not an option in this situation which is rather scary. If there’s been a saving grace for the eurozone over the last five years it’s that the ECB has been the one institution where Team Austerity didn’t always win out. If that changes we could looking at a very scary next phase of the evolution of the eurozone.

There was, however, the one thing Draghi said that should soothe markets and help hold the euro down: that interest rates would be kept low for an extended period. Although he also stated that the ECB Governing Council didn’t actually discuss whether or not rates will be raised before the end of QE. It could have been more soothing, although it could have been worse too:


The ECB chief also reiterated that interest rates will be kept low for an extended period, and said officials did not discuss whether they could be raised before net asset purchases end.

So maybe QE will be ended next year but rates will stay low for much longer. That’s the kind of signal that should at least help keep the eurofrom surging.

But, again, if the QE program is ended soon – say, in 2018 – the question of whether or not interest rates are going to be hiked before, or only after, the QE bond buying program ends is going to be moot in a year. t’s an example of easily the ECB’s soothing words can be undermined by the rest of signaling – official and unofficial signals – which is s an important point to keep in mind because we’re entering into a potentially precarious phase of the eurozone crisis – the unwinding stimulative measures phase – and if the ECB screws this up we could be looking at more crises. One of the easiest way for the ECB to screw this up is for it to inadvertently send signals that indicate the crazy Austerity Team is taking over completely and the markets are in for a giant shock and few things are going to shock markets and spike the euro quite like a rapid pull out of the ECB’s ultra-low interest rate position. So if there’s a miscommunication on matters related to the expectations for future rate hikes that could have a significant impact on the ECB’s ability to actually unwind the QE program given how tightly intertwined the QE program is with interest rates and currency valuations.

This is seriously tricky central banker stuff going on right now in the eurozone. If the ECB tries to calm the markets it just might make matters worse. But saying nothing doesn’t help either. These are very non-ideal conditions for the end something like QE.

The 2018 Unwinding of QE to Be, According to Three Anonymous Insiders

So given the situation the ECB finds itself in – and role public signaling for the ECB, or lack thereof, is playing in the development of that situation – it’s worth noting that, according to the following report based on three anonymous people privy to ECB Governing Council thinking, the ECB has already made quite a few decisions on these matters. Mostly scary decisions. But let’s start with the pleasant part: According to these insiders, the ECB has decided whether or not it’s going to raise interest rates before the end of the QE program: no, it won’t.

And in theory that would be a relief to markets and perhaps help bring the euro down. But it turns out not be be much reassurance given the rest of what these insiders allege: that the ECB has already decided to unwind the QE program next year. Specifically, the insiders say the ECB has already planning on significant cut to the month QE bond purchases starting in January, and are only debating whether to get it by 33-66 percent. And they’re planning on ending the program entire by the fall of 2018 . So the question of whether or not those ultra-low rates rise before or after QE ends is moot in a year if what these anonymous insiders say is true. It’s the kind of report that limits the ability of Draghi to reassure markets.

Also, according to the anonymous insiders, there will be no flexibility on the national QE “capital keys” caps [1]. They are non-negotiable and changing them (like lifting the 33 percent cap) would create legal challenges. If that’s truly the dominant position internally at the ECB at this point it’s a sign that Team Austerity – led by Wolfgang Schaeuble and Jens Weidmann – really is planning on ensuring QE effectively ends sooner rather than later whether or not there’s an officially declared end to QE. The national caps effectively put a time limit on the QE program. A limit that nations hit at different points and the nations that need it most tend to hit the caps first.

So there are now anonymous reports emanating from the ECB hinting at exactly the kind of policies that would call for a higher euro. And as we saw, if the ECB doesn’t give the final important details until its December 14th meeting that could be asking for trouble, leaving just 10 traditionally low volume market trading days before the end of the year. As we also heard from Mario Draghi, the official decision will probably come at the next meeting on October 26th. So it’s worth noting the other important policy stance indicated in the following article: the icing on the cake comes from Finland’s central bank governor and ECB board member Erkki Liikanen, who inform reporters that, while the ECB’s decision on QE might be made at the October 26th meeting, there would be a some “fine-tuning” on technical issues that prevent the final decision from happening until the December 14th meeting. And, of course, in a highly volatile environment, there could be a lot of technical issues. Especially after the ECB announces the plans these insiders are hinting at and especially if market speculation about ECBG Governing Council speculation of the markets leads the euro higher.

It’s possible this is anonymous bluster, but at a minimum it appears that Team Austerity inside the ECB, an enemy of QE all along, wants to make it look like it’s reasserting its control at the ECB level. That’s the signal the right-wing pro-austerity faction is sending to the markets via anonymous reports like the following one. And if it’s an accurate signal that means these ECB insiders just informed the markets that there’s a potentially significant shock coming up from the ECB and the shock won’t be finalized until December 14th, leaving just 10 trading days for the markets to work out at the end of the year. It’s the kind of message that’s probably not going to make Draghi’s job any easier.

It’s also important to note that these insider reports could be bluster from a minority faction. And specifically right now, this could be coming from the Berlin faction to placate the German electorate that has an election going on at the moment. Tough talk on QE is good politics in Germany’s election.

Still, the advance of the euro matters for the eurozone ‘periphery’ nation now forced to export their way out of the ‘austerity zone’. These are nations that have had one economic tragedy after another inflicted upon them in recent years and it would be a massive tragedy if the Team Austerity managed to create a euro spike that destabilized those same economies due to stupidly overreaching during the QE unwind. And even if the anonymous report isn’t real, it’s a real signal being sent through anonymous sources by Team Austerity to the public with the power to move markets by changing expectations [11]:

Reuters

Exclusive: ECB policymakers agree on cutting stimulus – sources

Reuters Staff
September 8, 2017 / 3:57 AM / Updated

FRANKFURT (Reuters) – European Central Bank policymakers agreed at their meeting on Thursday that their next step would be to begin reducing their monetary stimulus, three sources with direct knowledge of the discussion said.

After 2-1/2 years of massive money-printing, the ECB is taking baby-steps toward weaning the euro zone off the easy cash that has helped boost the economy but is also blamed for creating bubbles in richer countries such as Germany.

The ECB left its policies unchanged on Thursday. But President Mario Draghi suggested October would be decision time regarding the future of the 2.3 trillion euros ($2.8 trillion) bond-buying program. Policymakers debated various scenarios, he said.

The four options being considered for reducing its bond buying, according to sources who asked not to be named, include cutting its monthly buying from the current 60 billion euros to 20 or 40 billion from the start of 2018, with the scheme running for another six or nine months.

The decision was likely to come at the Oct. 26 meeting and should be backed by a broad consensus, the sources said. One suggested a compromise could be found for setting monthly purchases somewhere between 20 billion and 40 billion euros.

The sources added that much of the focus of the discussion was on the overall amount of the purchases, including the reinvestment of proceeds from maturing bonds, which will slowly rise toward 15 billion euros per month next year, the sources said.

The ECB declined to comment on the report, which pushed the euro and government bond yields in the single currency bloc higher.

INFLATION

Despite solid economic growth in the euro zone, inflation has yet to rise back to the ECB’s target of almost 2 percent and has been further curbed by a recent rise in the euro against major currencies, which makes imports cheaper and exports less attractive.

The rally in the euro was raising the chances that the ECB would opt to phase out quantitative easing only very slowly next year and may look for other ways to support the economy.

The sources said policymakers also agreed that interest rates will not be raised before the asset buys end, indicating by default that any extension of the program would also push out the first rate hike.

LIMITS

Any extension to the bond scheme will leave the ECB exposed to the risk of running out of eligible bonds to buy under the strict conditions it has set itself to limit market disturbance and not become a blocking minority in any country.

But the sources said the so-called issuer limit, which caps any ECB buying to a third of a country’s outstanding debt, is not up for discussion because it would open the program up to a legal challenge.

Maintaining the cap and the program’s other self-imposed constraints would curtail the purchases as the ECB is already approaching its limit in several countries – notably Germany, the euro zone’s biggest economy and the ECB’s top critic.

This meant the ECB may have to deviate even farther from the national quotas adopted at the outset of the program, which determine how much debt it can buy from each country depending on its shareholding in the central bank.

Indeed, the ECB has been buying fewer German and more Italian and French bonds than it is supposed to for months, with purchases of public-sector paper issued by Germany hitting an all-time low in August.

Some technical issues may have to wait until the ECB’s last meeting of the year in December, according to Finnish governor Erkki Liikanen.

“We have a meeting in October where we will address these issues, and it could be that the fine-tuning on these issues will be made afterwards,” Liikanen told the Finnish parliament on Friday.

———-

“Exclusive: ECB policymakers agree on cutting stimulus – sources” by Reuters Staff; Reuters; 09/08/2017 [11]

“The ECB declined to comment on the report, which pushed the euro and government bond yields in the single currency bloc higher.”

No comment from the ECB on the “let’s end QE in 6-9 months and slash bond purchase 33-66% in January and give the markets 10 trading days to adjust” rumored plans. *Gulp* Hopefully it’s just ECB policy not to comment on anonymous reports.

Still, that wouldn’t change the fact that there’s group of people in the ECB leaking a behind-the-scenes narrative to the press that the consensus decision has already been arrived at by the ECB Governing Council to cut QE dramatically in January and end it entirely by the fall. And while markets might not have been shocked to hear such a plan back in, say, mid April, when the euro was closer to $1.05 and not $1.20 , it’s a lot more surprising to hear plans to unwind QE in the first 6-9 months of 2018 now that the euro is $1.20 with plenty of momentum to head higher as QE unwinds.

But, let’s not forget that the opponents of QE – primarily the Bundesbank and its allies- were more than happy to call for an expensive euro back in 2013 when the eurozone’s ‘periphery’ economies were far closer to imploding than they are today [10]. So this insider report is surprising in a general sense given the obvious risks of an overvalued euro to the eurozone economies, but it’s not particularly surprising given who we’re talking about. Reckless policy s the austerity faction’s specialty.

And note how, even if there is a surprise ECB decision about QE and the other stimulus programs and the QE program is extended without big cuts to the monthly bond buying and no declared plans for shuttering the QE, the ECB’s “capital keys” cap on the QE sovereign bond buying at 33 percent of a nation’s outstanding sovereign bonds is still in place and not going anywhere according to these insiders. And that QE national cap is already forcing Portugal and Ireland to continually cut their participation in the QE program [1]. So when we hear that the changing the rules to lift those national caps is already ruled out by these insiders, we’re hearing a signal that QE is going to be allowed to end soon one way or another [12]: either QE will be wound down intentionally or eventually all the participating nations will eventually hit their caps and effectively end it anyway:


Any extension to the bond scheme will leave the ECB exposed to the risk of running out of eligible bonds to buy under the strict conditions it has set itself to limit market disturbanc and not become a blocking minority in any country.

But the sources said the so-called issuer limit, which caps any ECB buying to a third of a country’s outstanding debt, is not up for discussion because it would open the program up to a legal challenge.

Maintaining the cap and the program’s other self-imposed constraints would curtail the purchases as the ECB is already approaching its limit in several countries – notably Germany, the euro zone’s biggest economy and the ECB’s top critic.

This meant the ECB may have to deviate even farther from the national quotas adopted at the outset of the program, which determine how much debt it can buy from each country depending on its shareholding in the central bank.

“This meant the ECB may have to deviate even farther from the national quotas adopted at the outset of the program, which determine how much debt it can buy from each country depending on its shareholding in the central bank.”

And keep in mind that this report came out on September 8th, one day after ECB chief Mario Draghi told the market that the ECB is going to need the next six weeks to wait and see and observe the situation with the rising euro to determine its QE decision. It’s a pretty strong “trouble here we come!” signal for these ECB insiders to send to the market.

The Schaueble Consensus. That’s a Thing. Uh Oh.

Although, again, it’s entirely possible that the anonymous insider report is just a story intended to placate the German electorate or disinfo for some other reason. It’s an anonymous insider report and people spread false stories for all sorts of reasons.

But unfortunately, according to the following report in the Financial Times from September 6th, German Finance Minister Wolfgang Schaeuble – arguably the most powerful person in Europe and a consistent advocate for absolutely merciless applications of austerity doctrines – has views on these matters that are more and more in line with the ECB consensus. Not entirely. Schaeuble wants an end to all ECB stimulus policies (QE and low rates and anything else) sooner than people expect, as he puts it. And while it doesn’t sound like the ECB is on board with a complete rapid reversal of all stimulus programs, it does sound like Schaeuble’s views on ending QE completely next year is increasingly the consensus on the ECB Governing Council [13]

The Financial Times

Draghi faces another test to taper without tantrums

by: Claire Jones in Frankfurt
September 6, 2017

Mario Draghi has been wrestling with a €2tn issue throughout this year — how to rein in the European Central Bank’s quantitative easing programme without alarming the markets and slowing down the eurozone’s recovery.

Now, as the hour of truth looms for the €60bn-a-month asset purchase scheme — due to be discussed at Thursday’s ECB meeting ahead of a likely decision in October — attention is shifting elsewhere: notably, to interest rates.

“The ECB thinking into next year could be that what matters more for the euro is not the size [of] QE, but keeping…interest rate expectations anchored for as long as possible,” said Marchel Alexandrovich, economist at Jefferies International, an investment bank.

QE remains an intensely polemical topic as the ECB president can attest. Germany has always been uneasy about the bond-buying programme, while eurozone countries with lower levels of growth are much more enthusiastic about its impact on reducing borrowing costs.

Wolfgang Schäuble, Germany’s finance minister, called on Wednesday for the ECB to ditch such extraordinary crisis measures because of the strength of the eurozone recovery. “Unusual monetary policy implies it is not usual or normal — we should get back to a normal monetary policy,” he said. “We have come back to a normal situation much quicker than people thought.”

But, insofar as they refer to QE, Mr Schäuble’s remarks are in line with the consensus, which is increasingly confident of a decision next month to scale back asset purchases from January, so that the scheme can wind down next year.

Since the ECB risks running out of eligible assets if it continues purchases at their current pace and Mr Draghi has declared several times that his bank has vanquished the threat of deflation, much of the rationale for QE has gone.

That is not the case, the ECB argues, for interest rates.

At 1.5 per cent compared with a target of just below 2 per cent, inflation is still weak, partly because of the strong euro. [14] Core inflation is even more feeble, at 1.2 per cent.

There is broad agreement within the ECB’s governing council that any decision to increase rates from their current record lows could risk throttling the recovery, despite demand for higher rates from Germany and elsewhere.

At present, the main refinancing rate is zero while the deposit rate paid by banks is minus 0.4 per cent.

Despite the healthy eurozone recovery that brought growth to 2.1 per cent for the year to June, expectations of a rate rise in the medium term have dived [15] in recent months — particularly since a conference speech Mr Draghi gave in Sintra in June.

The initial aftermath of that speech, in which the ECB president said “deflationary forces have been replaced by reflationary ones”, was a jump [16] in the euro, as investors judged that there would be less reason in the near future to keep interest rates low.

But ECB officials hastened to say that Mr Draghi had been misunderstood [17], and his speech also argued that policy “needs to be persistent” because inflationary pressures were “not yet durable and self-sustaining”.

Since then, markets for futures contracts indicate that investors have gone from pricing in a 90 per cent chance of a rate rise by the end of 2018 to a 40 per cent chance — the lowest probability on record.

One central bank official close to the deliberations said the adjustment in interest rate swaps suggested “markets were finally taking our forward guidance seriously”. That is a reference to Mr Draghi’s near-constant refrain that the bank expects rates to “remain at their present levels for an extended period of time, and well past” the time when QE is finally brought to an end.

Bankers — particularly in Germany — are not happy about continued ultra-low interest rates. “The real economy is doing well, the market is expecting I think an increase in interest rates or a reduction in the negative nature of interest rates. Let’s start doing that,” said John Cryan, Deutsche Bank chief executive on Wednesday, referring to an issue that also concerns Mr Schäuble. “It can’t be forever that deposit taking is lossmaking?…for banks.

The markets’ struggle to interpret Mr Draghi’s remarks over the summer has also fuelled sharp rises in government borrowing costs and contributed to the euro’s rise.

The currency’s ascendancy means in turn that a new round of economic forecasts by ECB staff on Thursday will almost certainly show inflation weakening in 2018 — complicating the bank’s task of explaining why now is the time to exit, even though next to no one expects inflation to hit its target during the next couple of years.

“If you look back at what he has accomplished in the past two or three years, Mr Draghi is probably the most successful central banker there is,” said Michael O’Sullivan, chief investment officer in the international wealth management division at Credit Suisse.

“But on the euro, he hasn’t been that forthright. There is a danger that if he doesn’t feel the need to say anything on Thursday, then the currency could draw investors and appreciate further.”

Ken Wattret, economist at TS Lombard, a research firm, said: “Inflation is still rather low, so the ECB needs to make clear that the hurdle to embark on interest rate rises is much higher than the hurdle to tapering.

“What Mr Draghi should do on Thursday is put some distance between adjusting QE and raising interest rates. He ought to emphasise that policy adjustment will be very gradual. Otherwise he risks undermining the progress which it has taken such a long time to achieve.

———

“Draghi faces another test to taper without tantrums” by Claire Jones; The Financial Times; 09/06/2017 [13]

“Wolfgang Schäuble, Germany’s finance minister, called on Wednesday for the ECB to ditch such extraordinary crisis measures because of the strength of the eurozone recovery. “Unusual monetary policy implies it is not usual or normal — we should get back to a normal monetary policy,” he said. “We have come back to a normal situation much quicker than people thought.”

Those were Wolfgang Schaeuble’s comments on September 6th, the day before the ECB met and Mario Draghi issued his vague statement about how the ECB needs to wait and observe the situation before making any decisions on how fast to wind down the QE program. “We have come back to a normal situation much quicker than people thought.” So we have this message from Schaeuble, a supremely powerful figure, the day before Mario Draghi gives his “we’ll wait and see” speech, and then the following day we get the above report from the anonymous insiders that more or less is in line with Schaeuble’s message.

It’s rather ominous given Schaeuble’s influence because Schaeuble’s way of thinking is the default mode for how the eurozone seems to operate on all matters involving finance, except for ECB matters in recent years because that would have imploded the entire eurozone. So if Schaeuble’s way of thinking is about to replace Draghi’s relatively ‘dovish’ reign now that the eurozone is slowly recovering we really can’t rule out the ECB following Schaeuble’s lead and “renormalizing” back to a “a normal situation much quicker than people thought” over the next couple of years. Or at least much sooner than is economically appropriate (Schaeuble is a highly ideologically driven figure so economic appropriateness is never a priority for him).

But it’s extra ominous to hear Schaueble’s “renormalize it all (at any cost)” views in a report that describe’s Schaeuble’s views on QE as truly the behind-the-scenes consensus:


But, insofar as they refer to QE, Mr Schäuble’s remarks are in line with the consensus, which is increasingly confident of a decision next month to scale back asset purchases from January, so that the scheme can wind down next year.

As we’ve seen repeatedly over the past 5+ years, ever since the eurozone crisis really got into full swing, when Wolfgang Schaeuble calls for a policy it’s a call rooted in punitive Ordoliberal ideology, not practical economics. So to hear that Schaeuble’s views are the consensus view on almost anything is a big warning sign that the ideologues are once again taking over at the ECB.

But that’s the signaling coming out of the ECB and all powerful German finance minister heading into this crucial period for the eurozone economy. Ending QE was never going to be easy, but if the Ordoliberal ideologues are calling the shots during this QE wind down phase it could be a very bumpy ride. Officially, Mario Draghi is telling the markets to vaguely not worry because he’s promising to keep interest rates ultra-low for the foreseeable future even if QE is unwound next year, and maybe the ECB won’t end QE at all next year if the euro keeps surging. That’s the official message.

But unofficially the message from anonymous ECB insiders and Wolfgang Schaeuble is that the decision has already been made to kill QE next year, with rate rises presumably to follow. And if the markets decide to listen to that unofficial message instead of the official one the euro is going to just keep going higher and higher, potentially derailing the fragile export-based economic recoveries that are being used to justify ending QE in the first place.

And as the above article pointed, we saw what happens when the markets misinterpret the ECB. Back in June, when Draghi sounded like he was shifting away from guarding against deflation to guarding against inflation, the euro did exactly what you would expct: it jumped in value, contributing to the overvalued euro situation we have today:


Despite the healthy eurozone recovery that brought growth to 2.1 per cent for the year to June, expectations of a rate rise in the medium term have dived [15] in recent months — particularly since a conference speech Mr Draghi gave in Sintra in June.

The initial aftermath of that speech, in which the ECB president said “deflationary forces have been replaced by reflationary ones”, was a jump [16] in the euro, as investors judged that there would be less reason in the near future to keep interest rates low.

But ECB officials hastened to say that Mr Draghi had been misunderstood [17], and his speech also argued that policy “needs to be persistent” because inflationary pressures were “not yet durable and self-sustaining”.

But as the article also also noted, the markets have since taken the ECB’s officially messaging on interest rate guidance – don’t expect a rate rise for a while – to heart. So if there’s a decision, or market expectation, to raise interest rates soon after ending QE that could be a genuine surprise that would only send the euro higher:


Since then, markets for futures contracts indicate that investors have gone from pricing in a 90 per cent chance of a rate rise by the end of 2018 to a 40 per cent chance — the lowest probability on record.

One central bank official close to the deliberations said the adjustment in interest rate swaps suggested “markets were finally taking our forward guidance seriously”. That is a reference to Mr Draghi’s near-constant refrain that the bank expects rates to “remain at their present levels for an extended period of time, and well past” the time when QE is finally brought to an end.

Yep, markets were finally taking the forward guidance on interest rates seriously. Forward guidance that Draghi reiterated during his September 7th “we’ll wait and see” speech. And note that the current relatively high valuation of the euro has already priced in the assumption that rates are going to stay very low for an extended period of time. So, again, if there’s a surprise on higher rates sooner than expected don’t be surprised by a higher euro.

And, unfortunately, that forward guidance on rates from Draghi is the same forward guidance Wolfgang Schaeuble just completely contradicted on his September 6th comments. And the three anonymous ECB insiders who hinted at a rapid winding down of QE next year (end it in the first 6-9 months of 2018) didn’t help that official guidance either because plans for end QE next year could easily be interpreted as meaning the Schaeuble/Bundesbank faction is now completely calling the shots and that faction wants rates to rise “much quicker than people thought”, as Schaeuble put it.

So if there’s a surpise announcement that a rate rise could happen as soon as, say, next fall (after QE winds down) – or surprise unofficial signalling that the market takes to heart over the officizl signalling – that means the value of the euro is poised for some further surging. And the higher the euro goes, the less justified ending QE and raising rates becomes because that really can be a serious drag on weak economies just trying to export their way back to health after all the austerity threw them down a depression-level hole. A rising euro is a real problem for those plans to wind down QE next year.

But ending QE isn’t just a problem in terms of allowing ideology to take over from sober management and potentially destabilizing markets in all sorts of ways. The rising euro – which was always going to be a consequence of ending QE – also undermines the basic economic model that all the other EU nations were supposed to adopt after all the austerity they incurred. The Berlin-based Ordoliberal ideology [18] that dominates the EU’s economic policies countries was the basis of the austerity demands. Countries like Greece and Spain and Ireland where supposed to take on all sorts of austerity as part of the ‘medicine’ to transform their economies into mean, lean, export machines (with an emphasis on mean, apparently). If nations incur brutal austerity they will come out stronger than before. That was the implied social contract.

And that Ordoliberal exports-at-all-costs ideology has generally viewed the ECB’s extreme stimulus measures as an unnecessary crutch that doesn’t allow the market dynamics (high government borrow costs and possible national bankrupticies) to play their course and force the necessary pain required to create economies like Germany’s. That’s the insane ideology backed by Schaeuble that typically dominates EU and eurozone decision-making on all things financial and the only reason it hasn’t dominated at the ECB level over the past five years too is that it would have imploded the whole eurozone system. But it’s entirely possible the Schaeuble wing is going to take over for the Draghi wing at the ECB as the QE unwinding phase is happening and if that happens we could see the euro rise to levels that destroy any hope for countries like Spain and Portugal to turn themselves into mean, lean, export machines. The euro will be too strong for their exports. It’ll be the final insult to all the austerity they incurred: taking away the financial ‘punch bowl’ too quickly and killing the export sectors the ‘periphery’ nations created so far.

How possible is such a scenario, where the euro continues to rise, squashing weak recovery? Well, don’t forget that we’ve already seen how little the Bundesbank/austerity faction cares about an overvalued euro crushing the periphery economices. That was the case in 2013 when the value of the euro down in 2013 when the issue of an over-valued euro for the weaker economies was being debated [10].

And back in 2013 we didn’t have a whole array of stimulus measures set to be unwound that will mechanistically increase the value of the euro. But we do now and one of the key dangers in unwinding the ECB’s extreme measures like ultra low rates and QE has always been the danger of unwinding too fast. Stupidly fast. Ideologically stupidly fast. And that’s always been a danger Wolfgang Schaeuble and Bundesbank chief Jens Weidmann embrace.

Also don’t forget that the ECB has been careening towards a curtail-QE-at-all-cost modality all year and if the euro wasn’t surging the above plan would be very plausible. As we saw above, ending QE in 2018 – a move that just might mean 2018 is guaranteed to be an expensive euro year – is apparently the consensus view at the ECB Governing Council. It’s not the official signal, but it is the unofficial signal.

So while the ECB has officialy signaled to the world that it doesn’t know what it’s going to do yet because of the rising euro, unofficial signs are suggesting otherwise. And those unofficials signs point towards ECB plans that it can’t easily reveal to the markets because revealing those plans would spike the euro even more. And don’t forget, the longer the ECB waits to release its plans for next year the greater the odds of the final decision not being announced until the ECB’s December 14th meeting, leaving markets just 10 trading days left in December to process those plans. It’s quite a powderkeg situation that we’re seeing develop.

And that’s just the near-term risk we’re looking at over the next few months. The far greater long-term risk is the prospect that the austerity faction really is about to take over ECB policy making during this critical unwinding phase for QE and the rest of the ECB’s stimulus measures. That “renormalization” phase is the kind of phase that should take years to carefully execute and waiting for the right conditions. But as Wolfgang Schaeuble warned us, the austerity faction wants to see “renormalization” sooner than people expect. And as contemporary eurozone history warns us, folks like Wolfgang Schaeuble don’t actually care if their ideologically driven decisions end up damaging the eurozone’s weaker economies because that damage simply because an excuse for more austerity. Austerity is the ends and means here: creating a union of export powerhouses that derive their export prowess from their poorly paid workers [19]. If ending QE too fast harms all these ‘periphery’ economies and forces them to impose even more austerity to deal with a strong euro that’s not a bug. It’s a feature [20].