The arrival of helicopter money
from: Erwan Mahé, who argues that the ECB is getting really, really serious about its entire mandate
Money exists not by Nature but by law. Aristotle.
18 March 2016
In fact, I am going to talk about the ECB (European Central Bank) today because the other central banks did not veer far from expectations. The BOJ (Bank of Japan) is still trying to figure out why the yen appreciated following the implementation of its NIRP (Negative Interest Rate Policy), the FED (Cental bank of the USA) and the BOE (Bank of England) remain data dependent and worried about financial market turbulence whilst the SNB (Swiss National Bank) is keeping tabs on the CHF (Swiss Frank) .
As for the ECB, however, I have biting at the bit for days now, as I try to reconcile the behaviour of the various asset classes with the decisions communicated. All of the measures, especially the new focus on the central bank’s balance sheet (“Asset Purchase Programme”), as opposed to a heightened reliance on the NIRP, and on the new, potentially negative-interest rate TLTRO (Targeted Long Term Refinancing Operations) the beginning of ’Helicopter Money), are perfectly consistent with our suggestions (see the “new VLTROs” and a “Pumped up QE” sections of the last Thaler’s Corner) and are very positive for risky assets and macroeconomic data.
The ‘investors’ (in reality, CTAs entangled in algorithmic systems intersecting the euro-dollar parity, Euro Stoxx and the Bund) nonetheless noisily stumbled all over themselves, leading to impressive levels of volatility in recent days, such as the 6.5% intraday variation the day of the ECB meeting on the Euro Stoxx and 2.60% on the Bund! Although we find the ECB’s statement that it will henceforth only use the tool of negative deposit facility rates with parsimony to be praiseworthy (it amounts to a tax), I consider that the aforementioned ‘investors’ overreacted to Mr Draghi’s comment on the matter during the Q&A session, especially since his comment does not seem truly consistent with the ECB’s introductory text, published just beforehand.
I have the feeling that Mr Praet’s interview this morning in La Repubblica is an attempt to set things straight. So let’s examine this matter point by point.
Did Mr Draghi say there would be “no further cuts in the deposit rate”? Given my doubts about the exact comments made by Mr Draghi during the Q&A session, I went directly to the transcript published on the ECB’s web site: “Introductory statement to the press conference (with Q&A)” Here is the excerpt that is of interest to us (emphasis mine):
“How low can we go? Let me say that rates will stay low, very low, for a long period of time, and well past the horizon of our purchases. From today’s perspective, and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further. Of course, new facts can change the situation and the outlook. Let me also add that the experience we’ve had with negative rates, in our case at least, has been very positive, in easing financing conditions, and in the transmission of these better financing conditions to the real economy. We are also aware that – by the way, here there are different views about whether negative rates have affected, or how they affect, the profitability of the banking system. We can discuss this later.
But let me tell you: does it mean that any negative rate will be positive? Does it mean that we can go as negative as we want without having any consequences on the banking system? The answer is no. And you probably know that we’ve discussed for some time the possibility of having a tiering system, so an exemption system for this operation, and in the end the Governing Council decided not to, exactly for the purpose of not signalling that we can go as low as we want on this. So the Governing Council, although it gives a positive judgement about the past experience, is increasingly aware of the complexities that this measure entails.
…. So the bottom line of this is that basically more and more the emphasis will shift from rates instruments to other, non-conventional instruments. “
The markets thus reacted tempestuously to the phrase, “we don’t anticipate that it will be necessary to reduce rates further”, with a surge in the Eurodollar exchange rate to 1.1224 from 1.0822 in the afternoon! This lead to correlated movements on the Euro Stoxx and the Bund, triggering stops all over the place, to the benefit of our advised gamma positive positions. His conditional “from today’s perspective” and the much more positive aspects of the other measures announced were lost in all the noise, until the market calmed down, with the Euro Stoxx making up for all the lost ground the next day. We nonetheless experienced a very stressful shift Thursday morning, which I am unable to explain for the time being. Above all, readers who paid close attention to the ECB’s introductory statement noted the ECB’s precise formulation on the deposit rate:
“Finally, looking ahead, taking into account the current outlook for price stability, the Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.”
In ECB-speak, “at present or lower levels” has always signified a dovish bias. Mr Draghi’s answer thus seems a little strange to me in that it would seem to deny, everything else being equal, the possibility of a new rate cut, for example, in June, as priced in by the Eonia forward rates. I continue to believe that we should go with the introductory statement in which each word is carefully constructed and negotiated to accurately reflect the monetary policy decisions made by the Governing Council and the bias it sought to communicate. This feeling of mine was reinforced by the interview with Mr Praet an excerpt from which I provide below:
But do you think the market is right to believe there will not be more cuts?
In the Introductory Statement we said very clearly that we “expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.
So you haven’t reached the lower bound?
No, we haven’t. As other central banks have demonstrated, we have not reached the physical lower bound. This re-composition of the tool-box does not mean that we have thrown away any of our tools. If new negative shocks should worsen the outlook or if financing conditions should not adjust in the direction and to the extent that is necessary to boost the economy and inflation, a rate reduction remains in our armoury.
As readers know, I was not really a big fan of the acceleration of the negative interest rates policy as initially conceived, but it was especially the other ECB decisions, the magnitude of which I don’t think was sufficiently appreciated by investors, that justifies the maintenance of my positive bias on risky assets. Above all, the level of cash held in reserve by institutional investors at end-February was reportedly at the highest level since November 2001 (post 9/11) and higher than the worst moments of 2008-2009.
Let’s briefly examine these decisions point by point.
Low short-term rates for a very long time.
Longstanding readers know just how much I have warned against the risk of ‘niponisation’ of European monetary policy. I honestly believe that the NIRP has put us beyond that stage and that short-term interest rates will remain equal to or less than zero until, at least, 2019. In any case, that is the direction of the ECB’s forward guidance, given the comment that “interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases”.
Indeed, we do not know when the APP will really come to an end. For the time being, it is supposed to continue until March 2017, but it will be extended, if the 2% inflation target is not on the horizon. Moreover, beyond its poetic aspect, the interpretation of the phrase, “well past the horizon”, gives free reign to the imagination.
The extension of the APP to corporate bonds is Risk ON.
After being spurned in the wake of the tumult on the high-yield segment (US energy), this measure brings a gust of fresh air to this asset class, and the valuation consequences were immediate. Although it will reduce private sector yields, like with the conventional QE, we hope that the amounts at stake will be sufficiently low so that they do not detract from the desired goal. In any case, it wouldn’t take much to bolster the shift in the Portfolio Rebalancing Channel and for the Risk ON to spread to all corporate debt as well as to stockmarkets.
The new TLTRO negative rates are perfect (Helicopter Money).
This new TLTRO system, whereby the borrowing rates are, at worse, zero (0% refi rate) and, at best, -0.40% (current deposit rate) are (according to the FT) a mechanism imagined by Mr Massimo Rostagno (Head of Monetary Policy) and Mr Ulrich Bindseil. This is hardly surprising for the latter, who I have cited on various occasions for some insightful reports. He is one of those rare individuals, among central bankers, to have understood and integrated into his thinking the nature of a modern currency.
The reality of this measure, the official purpose for which is to compensate banks (that grant loans) via the neutralisation of the punitive aspect of the negative deposit rate by charging them at the same rate for their TLTRO, is fairly mindboggling, since it is the first true example of Helicopter Money! Indeed, for the first time in the history of central banking, private-sector agents (banks in this case) will be able to borrow money from the ECB and give back less than the capital borrowed, thanks to the magic of negative nominal interest rates!
The fact that the ECB does not lose money in this proces, since its resources are also financed by this same negative interest rate, changes nothing in the mechanism; it represents an income transfer from the public to the private sector. This is a veritable monetary policy revolution the consequences of which will take time to make themselves felt and which, as long as fiscal authorities do not act to offset the countercyclical lag in aggregate demand, will probably play an increasingly important role. As a case in point, check out another statement by Mr Praet this morning, which really reads like the end of a taboo:
But in principle the ECB could print cheques and send them to people?
Yes, all central banks can do it. You can issue currency and you distribute it to people. That’s helicopter money. Helicopter money is giving to the people part of the net present value of your future seigniorage, the profit you make on the future banknotes. The question is, if and when is it opportune to make recourse to that sort of instrument which is really an extreme sort of instrument.
There are other things you can theoretically do. There are several examples in the literature. So when we say we haven’t reached the limit of the toolbox, I think that’s true.
This need to use the Helicopter Money tool, in a context where a fiscal stimulus is politically not possible and when inflation is too low, has been a recurring thread of this letter for many years (“Print, don’t lend », Thaler’s Corner of 25-02-10). I am therefore excited to see this measure finally become part of the ECB’s “toolbox”, because the eurozone meets all the required criteria for its successful implementation. I also suggest that readers check out the site, PositiveMoney, which has been arguing for this approach for quite some time.
Here are few extra links for your reading enjoyment. I wish everyone a very relaxed and enjoyable weekend!
The Macro Geeks’ Corner (MG)
Ben S. Bernanke, Brookings, 18 mars 2016.
Tanweer Akram; The Levy Economics Institute, march 2016
Bloomberg, March 18, 2016
Have a good weekend!