ECB: No Change

Not surprising anyone, the ECB left its benchmark rate (which is at a ridiculous  1% anyway) unchanged today. Bloomberg reports:


„The European Central Bank kept interest rates on hold as inflation reappears on its radar screen, complicating efforts to bolster economic growth.

ECB policy makers meeting in Frankfurt today left the benchmark rate at a record low of 1 percent, as predicted by 56 of 58 economists in a Bloomberg News survey.


With widening economic divergences already making it harder for the ECB to set a common monetary policy, its response may be to do nothing. It will keep rates on hold at least through the third quarter of 2013, the median forecast in another Bloomberg survey shows.“


Doing nothing is always the best thing a central bank can do. It's not as though the ECB hadn't inflicted enough harm already. The fact that the ECB is trying to implement a 'one size fits all' monetary policy does indeed 'complicate' matters a bit. The euro area debt crisis is – inter alia – a direct result of this complication.

According to Reuters, the ECB altered both its growth and 'inflation' forecasts, while patting itself on the back over the results of the LTRO money pumping blitz – fleeting though they may prove to be.


Despite lowering its euro zone growth forecasts, it strengthened its rhetoric about a euro zone recovery, saying there were signs of a pick up, rather than the phrase "tentative signs" it has used since the start of the year.

The central bank also raised its forecasts for inflation this year, partly because of climbing oil prices.

"At least for the time being, a rate cut is clearly off the table … they took away the easing bias," said ING economist Carsten Brzeski. "They sounded a bit more positive but staff projections were worse … at least the chance of the euro zone falling off the cliff is very low right now."

ECB President Mario Draghi left little doubt that unless there was a relapse in the debt crisis, the bank had now done all it planned to in terms of extraordinary measures and that governments and banks needed to take up the baton.

"Both LTROs (3-year loan injections) have had such a powerful effect … we have to see exactly how the financial landscape has changed as a result," Draghi told the post meeting news conference.

"I think the ball is in the governments' and the other actors' – especially banks – court to continue their reforms, to repair their balance sheets so that they can actually support the – especially banks now – support the recovery."


In short, monetary pumping is off the table, until it is back on the table again. Climbing oil prices are of course not 'inflation', they are – for the most part – a result of inflation.

The report then lays out the details of the ECB's forecasts and notes that the EDC is now in 'pause mode' with regards to extraordinary liquidity provisions, which is precisely what was expected:


„The ECB's staff forecasts showed the euro zone economy could shrink by 0.5 percent this year and at best grow by a meagre 0.3 percent, a slight downgrade of its previous estimate but more upbeat than most private sector forecasts.

"Available survey indicators confirm signs of a stabilisation in the euro area economy. However, the economic outlook is still subject to downside risks," Draghi said.

Meanwhile, a recent 20 percent rise in oil prices is rekindling inflation to some extent. It is now forecast to be higher, at between 2.1 and 2.7 percent this year, well above the ECB's target of close to but below two percent.

"Owing to rises in energy prices and indirect taxes, inflation rates are now likely to stay above 2 percent in 2012, with upside risks prevailing," Draghi said, the first words of warning on inflation for well over half a year.#


We trust those unnamed private sector forecasts more, but as it were, such forecasts are in any case always subject to considerable uncertainty. What we do know for certain is that the flood of LTRO money and the laughably low interest rate are  having an effect: for instance, even in Germany and Austria, where  housing prices have been subdued for many years, incipient housing bubbles have begun to rear their heads. In other euro area member nations that have escaped the bust that has laid the 'PIIGS' low, housing bubbles have gone into 'overdrive'. Below are a few charts, via 'The Bubblebubble' site:



The incipient housing bubble in Austria – after having gone nowhere for many years, house prices have begun a 'parabolic' ascent around 2005.



Belgium's housing bubble is already in an advanced stage, and momentum seems to be slowing lately



Finland's house prices have also taken off in 2005 and after a brief pause in 2008/9 have re-accelerated as the ECB's money flood has come ashore.



Luxembourg's house prices are also zooming higher



The recent economic boom in Germany is the corollary to the collapse of the boom in the 'PIIGS': just as Germany was considered the continent's 'sick man'  while the 'PIIGS' boomed, it is now 'boom town' while the PIIGS economies contract. First it was Germany that was thought to require low interest rates, now it is the PIIGS that are thought to require them. In both cases, the administered interest rate turned out to be way too low, causing massive malinvestment and structural distortions. Germany currently enjoys an upswing that is very likely to ultimately lead to the same outcome – it is a central bank policy induced bubble destined to eventually burst.

The Reuters report continues:


'Sweetness and Light'

“Draghi was in no doubt that the ECB's twin three-year funding operations, which pumped over 1 trillion euros into the euro zone banking system, had saved the currency bloc from a serious crisis. Borrowing costs for debt strugglers such as Italy and Spain have tumbled as a result and Draghi said markets, including the interbank lending market, had reopened and "real money" investors were returning to euro assets.

"All in all, we see that great progress has been achieved," he said. "Simply compare what the situation was in November last year and what it is today."


Yes, print € 1 trillion and then make as though it were a great miracle that the markets are throwing a party. Meanwhile, there are the usual Teutonic party poopers trying to make everybody feel miserable about the wonders of the printing press:


While the euro zone economy has stabilised over recent months, in part thanks to the ECB's back-to-back rate cuts in November and December and the twin funding operations, there are growing signs of disquiet among some at the bank. Bundesbank President Jens Weidmann aired his concerns in a letter to Draghi last month. Juergen Stark, the ECB's influential former head of economics, added his criticism by telling a German newspaper on Thursday that the quality of the central bank's balance sheet was now "shocking".

Stark was one of two German members of the ECB policy-making fraternity who quit last year in protest at policies they felt overstepped the central bank's remit. Draghi denied there was any split this time, singling out Weidmann.

"My personal relationship with Jens is excellent … Nobody is isolated in the Governing Council and especially the Bundesbank is not isolated," he said. "I really cherish the culture and the tradition of the Bundesbank." [really? Promise? ed.]

In his letter, which was leaked on the day of the ECB's second dose of three-year funds, Weidmann wrote about the imbalances in the euro zone's payment system, TARGET2, and the resulting risks for the Bundesbank, which would be exposed in the unlikely event of the euro zone breaking up.

Draghi played down those concerns.

"The balance sheets of the other major central banks have expanded in a short period of time much more than the ECB's," he said. "So at the present time, to say that the risks for the ECB balance sheet are now higher than what they are in the Fed and in Bank of England is not correct."


As to which central bank balance sheet harbors the greater risks is really beside the point, although we strongly suspect that there is a lot more toxic garbage on the ECB's balance sheet than there is on the Fed's, all in all. Meanwhile, we discovered a few more nifty charts on the TARGET2 imbalances at German news magazine 'Der Spiegel', which we reproduce below:



The growing TARGET2 gap between the BuBa and the 'PIIGS' (these days this acronym is actually considered politically incorrect, because it reminds people too much of certain animals that like to wallow in the mud. Alas, we will stick to it. After all, whenever we think of the 'PIIGS', a big trough immediately comes to mind as well) – click chart for better resolution.



TARGET2 balances disaggregated. Not surprisingly, Italy and Spain have the  largest negative balances in absolute terms, but as a percentage of their total economic output Greece and Ireland are of course a great deal worse – click chart for better resolution.



We will see how long the good cheer lasts. To our mind, the final chapter of the euro area debt crisis story has yet to be written.


Debt Swap Optimism

As more and more institutions have announced that they intend to participate in the Greek debt swap, optimism has increased that it won't blow up in everybody's face. Nonetheless, we continue to believe that participation will in the end be enforced on a number of hold-outs via collective action clauses. We can not otherwise explain the fact that CDS on Greek debt continue to streak to new all time highs. It is possible that by the time this article is published, the results of the swap will already be known (the deadline is 10:00 p.m). In any case, a 'qualified majority' will probably participate.

Today there was apparently some last-minute profit taking in the CDS on Greek debt:


Investors cut Greek credit-default swap trades ahead of today’s debt exchange, pushing the amount of bonds insured to a record low $3.16 billion.

That’s down from a net $5.6 billion of securities protected last year, according to the Depository Trust & Clearing Corp, and compares with a swaps settlement of about $5.2 billion on Lehman Brothers Holdings Inc. in 2008. Five-year Greek contracts now signal a 97 percent chance of default, CMA data show.

Investors who bought debt insurance at lower levels may prefer to book profits now, rather than take their chances on a credit event and auction settlement, according to Harpreet Parhar, a strategist at Credit Agricole SA in London. Greece has said it may use collective action clauses, or CACs, to force bondholders to write down their holdings, and that would trigger payouts on credit-default swaps, according to rules of the International Swaps & Derivatives Association.

“It looks as if CACs are likely to be triggered and therefore the CDS, but it’s still not 100 percent certain,” said Parhar. “If you’re also worried about auction dynamics, it makes sense to close out positions.”

Greece retroactively inserted collective action clauses into bond documentation last month and may use them if the portion of investors who volunteer for the exchange falls short of its target. The addition of CACs didn’t trigger default swaps, ISDA ruled last week, though use of them would.

Investors are unsure whether Greece will invoke the clauses because officials including former European Central Bank President Jean-Claude Trichet have insisted against triggering default swaps, arguing that traders will be encouraged to bet against failing nations and worsen Europe’s debt crisis. Greek Finance Minister Evangelos Venizelos has said he’s not concerned whether the exchange triggers default swaps.

“If we can avoid the triggering of CDSs this is the best solution,” Venizelos said March 5. “With a near universal participation it’s not necessary to activate CACs. But this clause exists in our legal order and we are ready to implement the legislation if necessary.”


Trichet was of course always wrong about this. If the CDS do not get triggered on what is clearly a default, then it means investors can no longer hope to legitimately hedge their bond portfolios against the inevitable results of the unconscionable profligacy of the political class. In that case, as we have pointed out on many occasions, only one course of action remains: sell.

Nonetheless, as you can see below, CDS on Greek debt ended on Wednesday at a new all time high of 24,230 basis points.


Credit Market Charts

Below is our customary collection of charts,  updating the usual suspects: CDS on various sovereign debtors and banks, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Wednesday's close.

CDS on Greece are not the only ones shooting up again. Spain and Portugal are also back at the forefront of the market's concerns.

France, Belgium and Ireland also all saw their CDS spreads increase again. Sovereign debt CDS in the CEE nations also bounced. Of course one never knows if this is merely another short term bounce or a beginning trend change, but eventually we expect the previous uptrends to reassert themselves. As it were, the Markit SovX index continues to look quite bullish.



5 year CDS on Portugal, Italy, Greece and Spain – click chart for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – the recent bounce continues – click chart for better resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – click chart for better resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click chart for better resolution.



5 year CDS on Romania, Poland,  the Ukraine and Estonia – click chart for better resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – click chart for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns –  the SovX continues to look bullish to us – click chart for better resolution.



Three month, one year, three year and five year euro basis swaps. Once again looking better, so the dollar funding problems of euro area banks are clearly easing – click chart for better resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – a small dip in this index – click chart for better resolution.



5 year CDS on two big Austrian banks, Erste Bank and Raiffeisen Bank – ticking up again – click chart for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – Portugal looks ever more iffy – click chart for better resolution.



UK gilts, Austria's 10 year government bond yield, Ireland's 9 year government bond yield and the Greek 2 year note – click chart for better resolution.



5 year CDS on Australia's 'Big Four' banks – click chart for better resolution.




We have recently made a few cautious remarks about the economic outlook of the Ukraine. Although CDS on Ukrainian debt have in the meantime eased off in concert with those in euro-land, we continue to believe that our assessment remains warranted. In this context, we would like to point our readers to a recent article on the Ukraine by Edward Hugh at Creditwritedowns. Edward is an economist specializing in the effect of demographics on economic growth and development, and his articles are always very meticulously researched and offer interesting insights. In this case the topic may be a bit off the beaten path – not too many people worry about the Ukraine – but it should be noted that e.g. Austria's banks have very large exposure to the country, so what happens there is bound to redound on Europe through this as well as other channels. Needless to say, the Ukraine is a very interesting case from the standpoint of demographics, as its population growth is in steep decline.

Finally, in the context of our recent article on China, we would like to point out this brief write-up on China's slowdown at the Variant Perception blog, which argues that 'China's slowdown takes a turn for the worse'. 




Charts by: Bloomberg, Der Spiegel.


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2 Responses to “The ECB Decision, Greek Debt Swap Optimism”

  • mc:

    The ECB never heeds Bastiat: “Let us accustom ourselves, then, to avoid judging of things by what is seen only, but to judge of them by that which is not seen.” We can see that not triggering CDS would save some ill-managed banks money, but what is not seen?

    “If the CDS do not get triggered on what is clearly a default, then it means investors can no longer hope to legitimately hedge their bond portfolios against the inevitable results of the unconscionable profligacy of the political class. In that case, as we have pointed out on many occasions, only one course of action remains: sell.” The ultimate irony is that the politician does not want CDS triggered because they are a market mechanism for pricing political profligacy.

    I think you should rename this blog “the unconscionable profligacy of the political class”.

  • As you have said many times Pater, you can’t make this stuff up. But, it appears the ECB and those around it can make anything up. What is laughable is the idea that credit default swaps make the credit of countries bad. I suspect those tendering their settlements to Greece may have sizable CDS liabilities as well.

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