Category: European Central Bank

Is Mario Draghi pulling away the punch bowl?

“Draghi hints ECB may start winding down QE,” read the MarketWatch headline this morning:

European Central Bank President Mario Draghi hinted on Tuesday that the ECB might start winding down its large monetary stimulus as the eurozone economy picks up speed, even as he warned against an abrupt end to years of easy money.

The comments, at the ECB’s annual economic-policy conference in Portugal, come as investors watch closely for a sign that the world’s second most powerful central bank is preparing to withdraw controversial policies such as its EUR60 billion ($67.52 billion) a month bond-buying program.

Mr. Draghi said the ECB’s stimulus policies are working and will be gradually withdrawn as the economy accelerates. However, he warned that “any adjustments to our stance have to be made gradually, and only when the improving dynamics that justify them appear sufficiently secure.”

With the Fed now talking about contracting its balance sheet and the BOJ and ECB doing the heavy lifting, this seems like a big deal, yet equity markets have barely noticed.  The Euro Stoxx index was -0.13% while S&P 500 futures are currently -0.07%.  3-month VIX futures (Oct contract) stand at just 14.25. The eurozone sovereign debt markets are a different matter:

Germany 10-year = -0.56% (0.32% yield-to-maturity)

France 10-year = -0.59% (0.69% ytm)

Italy 10-year = -0.80% (1.98% ytm)

“Today Draghi moved his first step towards indicating that ECB monetary policy will become less [stimulative] in 2018,” said Marco Valli, an economist with UniCredit in Milan.

Mr. Valli said the ECB might reduce its monthly bond purchases to EUR40 billion in the first half of next year, followed by a further reduction to EUR20 billion per month in the second half of the year. That would be a slower pace of stimulus reduction than many analysts had been expecting.

Keep in mind, the ECB and Bank of Japan have been doing the heavy lifting as year-over-year growth in total assets shows:

Fed = 0%

ECB = +36.7%

BOJ = +20.0%

The bond markets are starting to pay attention (though still wildly delusional). Perhaps the equity markets should as well.

Can Cyprus create a contagion within the EU?

Over the last week Cyprus has made front page news as the country teeters on the brink of insolvency.  Knowing the powers at be have stricken the word from their playbook, or replaced it with “liquidity issue”, one must now consider the fate of the EU.   How can this be when Cyprus is a tiny .2% of eurozone GDP?   Consider this, according to the latest bank figures from the BIS, European banks had $38 billion of exposure to Cyprus!   In addition, last week the ECB threatened to withdraw emergency lending access (ELA) to the Central Bank of Cyprus unless they move forward with the proposed bank bail-in restructuring.

Cyprus has proposed the idea of a bail in as a way to recapitalize their insolvent banking system whereby depositors above and below 100,000 euros will be given haircuts of 9.9% and 6.75% respectively.

Of course, this completely violates traditional bank restructuring laws where depositors are the last party in line to incur any losses.  Which then begs the question, “why is the ECB trying to protect bondholders”?

Lets take a step back and review the moving parts in this game.  First, Cyprus is a low tax haven for Russian oligarchs while total deposits from Russia are somewhere near $26 billion or 130% of Cypriot GDP.  Total bank deposits are approximately $140 billion.

Over the last week the Central Bank of Cyprus has been posting sovereign debt at the ECB window, with undisclosed haircuts, in order to keep a lifeline open for the banks (which have been closed over this period of time).  During the Greek crisis haircuts ranged from initial 25% to 50% as the situation worsened due to strings attached by the ECB.

Final comments:  Why all of a sudden are the Cypriots being threatened by a complete removal of ELA by the ECB unless a bail-in is imposed on depositors?  Could one reason be the $9.7 billion in German bank exposure to Cypriot banks?  Or is there really no collateral, unlike Greece, so the ECB has no choice but to go after Russian oligarchs with a 10% money laundering fee?  Either way, the tiny country of Cyprus has already set off Spanish and Italian bank runs as the EU periphery prepares for possible bail-in aka ECB theft operations.  Now all we need to see is Mario Draghi making a statement, a la Ben Bernanke at the outset of the subprime bubble bursting, “Cyprus is only .2% of ECB and remains contained”.

WordPress Themes