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Posts Tagged ‘spreads’

Lagarde: A Rookie Mistake?

March 12, 2020 Leave a comment

So the ECB has spoken in response to the Coronavirus crisis, and it was a problematic response to say the least. I watched Christine Lagarde’s Q&A with journalists, which as usual was the most interesting part of the press conference. But boy, I wish today it had not taken place…

The bottom line is that Lagarde made a huge misstep in stating that the ECB is not going to close the spreads. I hope it is just a communication misstep, otherwise Italy (and probably other countries) will pay a heavy price.

But let’s see what happened today.

First, there is an attempt to put on the Eurozone governments’ shoulders most of the burden of reacting to a shock that will be “significant even if temporary”. Lagarde said clearly, towards the end of the press conference, that what she fears most is insufficient fiscal response coming out from the Eurogroup meeting next Monday:

It is hard to disagree with this approach. To target firms’ liquidity problems one cannot count on banks alone, (especially in countries where they have still not completely recovered from the sovereign debt crisis). As a side note, I welcome the provisions contained in the Italian €25bn package, such as the temporary lifting of short-term businesses obligations towards the government (VAT, social contributions, taxes). These seem to be the right measures to ease short term liquidity constraints.

But let’s look into what the ECB itself commits to do. Besides technicalities that I did not study yet, there will be two sets of measures:

  1. The first set concerns (continued) provision of cheap liquidity to banks, in order to ensure continuing supply of credit to the real economy. This will be ensured through a new and temporary long-term refinancing scheme (LTRO), together with significantly better terms for the existing targeted loan programs. This amount to a large subsidy to banks. Loans conditions will be more favorable for banks lending to Small and Medium Enterprises, which are the ones more likely to become strapped for liquidity in the current situation. Furthermore, as a supervisor, the ECB engages in operational flexibility when implementing bank specific regulatory requirements, and to allow full utilization of the capital and liquidity buffers that financial institutions have built. I am unclear on how much this will work in order to keep the flow of credit flowing, but overall, my sentiment is that on cheap and easy financing to banks and (hopefully) to firms, there is little more ECB could do.
  2. The second set of measure is a ramping up of QE, with additional €120bn (until the end of the year). Lagarde seemed to suggest that the ECB could use flexibility to deviating from capital keys, the quota of bonds the ECB can buy from each country. This means that maybe more help will be given to countries like Italy, and the ambiguity was probably on purpose.

But then came the Q&A, and with it, disaster. At a question by a journalist on Italian debt and yields, Lagarde replied the following:

This also made it on the ECB twitter feed:

This simple sentence was a reversal of Mario Draghi 2012 “whatever it takes“. Mario Draghi, in 2012, had basically announced that the ECB would act as a crypto-lender of last resort (conditional, way too conditional, but still), and since then the scope for speculation has been greatly reduced. Spreads have been much less variable since then (I wrote a paper with Roberto Tamborini, on that, that just came out).

Protection from the ECB against market speculation is what countries like Italy would need most. Fiscal policy is the tool that can be better targeted towards supporting the supply side of the economy and preventing liquidity problems from evolving into bankruptcies. Lagarde herself stated it many times in the past few days, and again today.

So, governments should be put in the conditions not to worry, at least for a while, of market pressure. Lagarde should have said the exact opposite: “we commit to freezing the spreads for n months so that governments can focus on supporting their productive sector, and restoring more or less normal aggregate demand conditons”. Lagarde said the opposite. And here is the effect of that on Italian ten year rates. Look what happened at around 3pm, when she answered the question:

The yields Other Eurozone peripheral countries had similar behaviours. Why did Lagarde say that? Maybe Because she wanted to appease fiscal hawks ahead of the Eurogroup meeting of next week, so that they are more willing to agree on a fiscal stimulus? Or because she was afraid to be accused to be too soft on Italy? Or to actually care about one single country, which is what the ECB is not supposed to do? Or was it simply a communication misstep? A rookie mistake? Whatever the reason, it is clear that Lagarde made a huge mistake, and even apparently she partially backpedaled in a NBC interview shortly thereafter, this is what remain of today’s press conference.

So, my assessment of today’s ECB move is mixed. It was as good as it gets on financing the banking sector, and we just have to cross finger that this is enough to keep credit flowing.

But it is disappointing on the support of expansionary fiscal policies. All the more disappointing that the ECB and Lagarde have insisted on the need for a fiscal response “first and foremost”.

My only hope is that that was a misstep, or just lip service to fiscal responsibility. If market pressure prevents governments from supporting their firms, and if liquidity problems evolve into solvency problems, a “significant but temporary” shock will become a permanent hit to long-term growth capacity. And let’s not forget that the Eurozone economy is today more diverse and less resilient than it was in 2008.

Brace yourself

ps. You can find my live tweeting during the Q&A (a bit confused at times. Live tweeting is not my thing!) here:

The Tree and the Forest

September 7, 2012 10 comments

What to do of yesterday’s decision of the ECB? The tree looks very rather nice, the forest much less. First, a look at what Mario Draghi announced:

  • “[…] the Governing Council today decided on the modalities for undertaking Outright Monetary Transactions (OMTs) in secondary markets for sovereign bonds in the euro area. […] We aim to preserve the singleness of our monetary policy and to ensure the proper transmission of our policy stance to the real economy throughout the area. OMTs will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro. […] we act strictly within our mandate to maintain price stability over the medium term.” The technical note accompanying the decision explicitly states what markets wanted to know: “No ex ante quantitative limits are set on the size of Outright Monetary Transactions” In other words, bond purchases will be unlimited.The technical note also specifies the conditionality, the fact that the purchases will be on short maturities, and that they will be fully sterilized.
  • Let’s go back to Draghi: “we decided to keep the key ECB interest rates unchanged.  […] inflation rates are expected to remain above 2% throughout 2012, to fall below that level again in the course of next year and to remain in line with price stability over the policy-relevant horizon.

To summarize, the ECB will try to bring down the spreads, acting within its mandate, because speculation is perturbing the transmission mechanism of monetary policy and threatening stability.  This can also help explain the decision to keep the rates unchanged: there is no point in using that lever, unless it is  sure it works.

Why is the tree rather good? And what makes the forest more worrisome? The tree first.

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Spiraling

July 4, 2012 Leave a comment

Istat, the Italian statistical office, just released its Quarterly non-financial accounts for the General Government. As were to be expected, deficit is spiraling out of control (8% on the first quarter, against 7% in 2011), because of higher borrowing costs, and because the economy is doing very poorly.

Two days ago  they released the provisional  unemployment figures for May:  stable above 10% (youth unemployment is at 36.2%!).

It seems that we come full circle, robustly installed in a Recession-Deficit-Austerity-Recession-Deficit-and-so-on spiral.

Austerity works, right?  Why on earth, should Italy aim for a balanced budget in 2013? Is this required by current European rules? No(t yet). Is this reassuring markets? No. Is this boosting private expenditure? No. Is this killing the Italian economy? Yes.

Ah, and if at least we did something for those spreads…

Germany Begins to Feel the Pain, Episode II

November 24, 2011 1 comment

It had to be expected.  Yesterday Germany only placed 3.9bn euros  worth of 10-year bonds, from 6bn euros on offer, and the yields started climbing. This means that we are quickly entering into a new phase of the euro crisis.
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(Bad) Arguments Against Debt Monetization

November 21, 2011 3 comments

I think it is useful to list, and assess, the main arguments advanced against an enhanced role of the ECB as a lender/buyer of last resort. I can think of four of them: credibility, inflation, irrelevance, ineffectiveness.

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It’s the Eurozone, Stupid!

November 18, 2011 1 comment

There are two interesting developments in the eurozone crisis.

  • The first is that there seems to be no discrimination coming from financial markets anymore. The French (and Dutch, and Belgian, and counting…) spreads are dangerously increasing, not for objective reasons, but rather because France (and then Belgium, and the Netherlands, and counting…) is perceived as the next country in line after Italy. It is clear that the process will not stop, and that today the only investment that is considered safe is German bunds.
  • The second development is that besides the German government, the  Bundesbank president, and of course the ECB, there is increasing consensus that only a radical shift in monetary policy can stop contagion, building a firewall around eurozone sovereign debt. It is impossible to have well functioning bonds markets with 17 governments de facto borrowing in foreign currencies, and without a lender of last resort.

The two developments are of course related. It becomes increasingly clear that national government, independently of their past wrongdoings or virtuous behavior, are less and less responsible for speculative attacks, that seem to be fueled by the perceived flaws in the EMU governance design: countries with very limited fiscal space and even more limited fiscal pooling, borrowing in a foreign currency without a Lender of last resort umbrella, and experiencing increasing external imbalances.

As somebody would have said some time ago, “it’s the eurozone, stupid!

Paul Krugman on the End of the Euro

November 9, 2011 Leave a comment

There is no need to write a post on the latest developments in Italy and in the eurozone. Paul Krugman says better than I could, how close we are to Armageddon.
There is only one very minor point of dissent, that for once makes me less pessimist than he is. I give more importance to the Italian internal factors than he does. If a solution is found to the current political turmoil, there may be a truce in the speculative attacks, and the spreads may go down to more manageable levels.
It remains true that without a rapid u-turn of the ECB, speculation will not be defused.