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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].