Relevant and even prescient commentary on news, politics and the economy.

OXI ~ 60%: What now? Greece Open Thread

Greece Interior Ministry Results
all regions voting ‘OXI’ = ‘No’

Huffington Post: Live Updates: Greece Votes In Referendum On Bailout Proposal

More links as afternoon progresses.

This article by Steve Randy Waldman at Interfluidity has been getting a lot of play around the Intertoobz since yesterday (I also linked to it in Comments on the previous Grexit post). It’s title is simple but it has a lot of depth and insight, I thoroughly recommend it. Greece

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ECB Rates Policy is Clogged in Key Periphery Markets

by Rebecca Wilder

ECB Rates Policy is Clogged in Key Periphery Markets

How the Euro area (EA) will grow, according to Mario Draghi:

The outlook for economic activity should be supported by foreign demand, the very low short-term interest rates in the euro area, and all the measures taken to foster the proper functioning of the euro area economy.

In this post, I address Draghi’s point that the ECB 1% refi rate will support economic activity through the lens of the mortgage market. Specifically, I find that the interest rate channel is clogged in the economies that are in most desperate need of lower rates: Spain, Portugal, and Italy.

Regarding ‘very low short-term interest rates’, what Draghi means is that the standard interest rate channel of monetary policy will stimulate domestic demand via increased spending by consumers and firms. If ECB policy is indeed passing through to retail credit (households and firms that borrow from banks to buy goods and services), then we should see evidence of this as falling interest rates to retail credit sectors, like those for consumer goods, home mortgage lending, loans for businesses, or even corporate credit rates to finance business investment.

In mortgage markets, the Euro area average borrowing rates are indeed falling. Banks started lowering mortgage borrowing rates, on average, in September 2011 in anticipation of ECB rate cuts that eventually occurred (again) in November 2011. Specifically, average Euro area mortgage rates are down roughly .25% since the local peak in August 2011.


But a closer look across mortgage markets shows a worrying trend for key periphery economies. The pass-through from ECB rate setting policy to mortgage borrowing costs is clogged in Spain, Portugal, and Italy, where mortgage rates have risen since the ECB cut the refi rate to 1%. Indeed, these are the economies that ‘need’ the stimulus to offset the fiscal consolidation.
Sure, mortgage rates are arguably low – but they’re not lower.

In Spain and Portugal, 91% and 99% of their respective new stock of mortgages sit on variable rate loans, so the pass through to the real economy should be rather quick IF mortgage rates declined (see Table below). True, Spain and Portugal are unlikely to experience any boom in real estate lending over the near term. However, had the ECB policy lowered mortgage rates, then disposable income would rise via lower monthly mortgage payments, thereby stimulating other sectors of the economy, all else equal.

In Italy, just 47% of the mortgage market is variable, so the immediate stimulus would be more muted compared to Spain and Portugal via disposable income. However, Italy didn’t experience a credit boom, so lending to firms and households could and should be warranted. But amid the fiscal consolidation and stressed debt markets, fewer borrowers are credit worthy AND mortgage rates have risen near 1% since EA mortgage rates peak on average in August 2011.

Core mortgage rates are falling, and this could create a positive stimulus for Spain, Portugal, and Italy down the road. But for now, the transmission mechanism, dropping the ECB refi rate to 1%, is not easing housing and mortgage financial conditions in those economies hit hardest by fiscal austerity.

Rebecca Wilder

Reference Table: reference for variable rate share of mortgage market

originally published at The Wilder View…Economonitors

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Sources and Uses: Kash Delivers

Two posts on European Banks and their view of what constitutes a “Safe Harbor.”

His conclusion isn’t just The Pull Quote of the Year, it’s the Pull Quote That Explains the Year:

Putting it all together yields a compelling story: European banks are shifting their cash assets out of European banks and putting much of them into US banks. (An interesting question is what European MFIs have done with the remaining money they’ve withdrawn from the European banking system… but that’s a story for another day.) This has happened at a significant rate, with a net transatlantic flow from European to US banks that probably totals close to half a trillion dollars in just six months.

If you’re wondering exactly who has been the first to lose confidence in the European banking system, look no further. It seems that at the forefront is the European banking system itself.

Go Read the Whole Things

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Malicious ECB rate hikes

by Rebecca Wilder

Lieblings quote of the day by Dean Baker:

“The ECB is run by a perverse cult that worships 2.0 percent inflation and is prepared to sacrifice almost all other economic goals to meet this target.”

The article goes on to argue that the ECB should increase its inflation target to 3-4% in order to facilitate positive wage growth in the debt deflationary economies like Spain. I’ve argued a similar point in the past.

However, I’d like to add that this “perverse cult” called the European Central Bank (ECB) raised its policy rate on April 13 – a point in time that correlates perfectly with a shift in trend across euro-area bond markets. Specifically, April 13 marks the upswing in risk premia on Italian, Spanish, and Belgian bonds relative to German bunds. Hmmm…policy mistake?



Now that’s just malicious.

Rebecca Wilder also posted at Newsneconomics

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Kash is En Fuego Today

Go. Read.

  1. US Bank Exposure to Greece, part 3. The FT lets someone from Nomura argue that Kash’s declaration of U.S. bank exposure to Greek default in Part 2 (referenced here, but just go to Kash’s link for the gist) was overstated.

    Nomura and The FT lose the argument, badly.

  2. Disasters for an economy — either real or financial — are not always disasters for the economy’s currency.”* Good to think of in combination with this piece from Barry Ritholtz.

*I may write up more using this when I can do some charts and graphs. It is starting to appear as if no one other than Dr. Black understands The Whole of The Euro Story.

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ECB policy is tightening – has been for some time

Update: Nouriel Roubini front pages this post on Euromonitor here.

The ECB dove in and hiked its policy rate by 25 basis points to 1.25%. I had the pleasure of listening to Wolfgang Munchau on Thursday, and he reiterated what I reluctantly understood: the ECB’s strict inflation target is ridiculously simple for such a complex region; but more importantly, the Governing Council is just itching to tighten.

Eurointelligence blog highlights the various interpretations of the ECB’s shift in policy: Thomas Mayer at Deutsche Bank suggests that the ECB’s normalization is appropriate, while David Beckworth and others (links at Beckworth’s site) are more sympathetic to the impact on the Periphery. They highlight that relative price fluctuations could facilitate the much-needed redistribution of capital flows (i.e., the current account); and furthermore, that ECB policy is even too tight for the core (a google translation of Kantoos Economics). Yours truly has written extensively about this – among others, here’s one, another, and another. Who’s right? Ultimately time will tell.

But I do suspect that we haven’t seen the end of this crisis. The ECB is squeezing out liquidity when more liquidity is needed. Furthermore, the core remains subject to export shocks via external demand; and there’s building evidence that global growth will slow (see this excellent post on global PMIs by Edward Hugh).

It’s ironic, too. While the ECB is currently being heralded or chastised for raising rates, monetary and financial conditions in Europe have been tight for some time, both on a relative and stand-alone basis!
(read more after the jump!)

First, the ECB’s bond purchase programs, the Securities Market Programme and the Covered Bond Purchase program, amount to just 1.4% of 2010 Eurozone GDP. In stark contrast, the size of the Fed’s program broke 16% (and is rising) and the Bank of England’s purchase program remains firm at around 13% of GDP.


The asset purchase programs are emergence liquidity programs and are not normal monetary policy tools. But while the Fed and the BoE do not sterilize their flows, the ECB does. And my interpretation of ECB rhetoric and policy as of late is that they want out of the secondary-bond purchase business. For example, they’ve slowed their SMP purchases markedly in 2011 (see the ad-hoc announcements here).

Second, Eurozone financial conditions have been tightening since August 2010, while those in the US and England loosened up. Goldman Sachs constructs a financial conditions index, which is comprised of real interest rates (long and short), real exchange rates, and equity market capitalization. I love this index (subscription required), as it represents a broad measure of monetary policy pass-through.

Even though the ECB just started its rate-hiking cycle, they’ve been effectively tightening for some time.

I would say that Eurozone (as a whole) growth prospects are seriously challenged at this time, especially by comparing monetary policy to that in England and the US. We’ll see if the ECB’s able to push its target rate back to 2.5-3% through 2012 – I suspect that may be just a pipe dream, as tight liquidity and a slowing global economy drag economic growth.

The ECB’s actions imply to me that they still do not understand the following: Europe faces a banking crisis not a fiscal crisis!

Rebecca Wilder

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Evidence says the ECB is overreacting

Earlier this week I argued that the ECB’s inflation target of just below 2% is too simplistic, especially during periods of supply-side price shocks: energy, food, VAT hikes. Here’s a menu of reactions to the ECB’s announced rate hike (Trichet used the phrase ‘strong vigilance’, which historically is a leading indicator of a rate hike in the following month): Paul Krugman calls it ‘madness’; David Beckworth sports the ‘black eye’ metaphor; Kantoos is somewhat more explicit in his language; and Warren Mosler goes for the Disney theme.

And then I see that one of my favorite blogs, the Eurointelligence blog, interprets the policy response as warranted in the face of an ‘overheating’ export sector. From Eurointelligence:

(It is our interpretation that the ECB is very keen to drive up the euro’s exchange rate against the dollar to reduce the commodity price shocks, and to reduce the overheating in the export sector. This is why the ECB was keen to signal this interest rate as early as possible, to underline the transatlantic policy gap. We don’t think the ECB intends to hike interest rates to very high absolute levels, though we consider a 2% year-end rate realistic.)

RW: My initial reaction was: what? Am I missing something here? Is the ECB right to be strongly vigilant? Is the export sector (1) overheating? and (2) therefore unmooring Eurozone inflation expectations?

No.

Exhibit 1: Real exports are 1.5% below the pre-crisis level (1H 2008). No overheating there. Based on the chart below, whose data are from Eurostat, I’d even argue that there is a possible stagflationary scenario on the horizon if investment doesn’t pick up.

If it’s not the export sector, perhaps it’s a broader impetus to prices driven by services and consumption goods. No.

Exhibit 2: The chart below illustrates the diffusion of HICP inflation (the ECB’s target inflation index, which is a consistent measure of inflation across the 17-member currency union). I calculate the diffusion index to measure the breadth of prices that are rising at a rate of 2%: > 50 and there’s a larger share of sub-components prices increasing at a greater than 2% annual rate, or
The breadth of Eurozone 2% price gains is very low, 31, or 31% below its historical average (45).


We know that headline inflation is estimated at 2.4% in February, or about 0.4% above the ECB’s comfort zone – perhaps that’s passing through to inflation expectations.

Exhibit 3: The chart below illustrates near-term Eurozone inflation expectations, as measured by the 5-yr inflation swap. (Note: and inflation swap is a market security that allows an investor to hedge against inflation by paying a fixed rate and receiving inflation-linked interest payments in exchange). According to the swap market, inflation expectations are priced at 2.151%; this appears well-anchored especially compared to the 2007 period when it drifted upward.


Another measure of inflation expectations, the ECB’s Survey of Professional Forecasters, sees inflation peaking in 2011 at 1.9%. No unmooring of inflation expectations there.

Related to the chart above, perhaps the ECB is looking at the sharp upward trajectory of inflation expectations in the swap market since October 2010 as unhealthy. No. That trajectory in inflation expectations is just a re-emergence of normalized inflation expectations, as the Fed worked to re-establish the US price trajectory. Global inflation expectations turned from drifting downward to a trend rate. Then perhaps it’s that Eurozone inflation expectations are outpacing those in other developed economies. Again, no.

Exhibit 4: The chart below illustrates the 5y5y forward break even rates of inflation for the US, UK, and the Eurozone, which is from page 84 of the ECB’s February (yes, this month) monthly Bulletin. The Eurozone is definitely the laggard here!

My interpretation of these statistics – and yes, there are many ways to measure inflation – is that the ECB is overreacting to the inflation pressures coming from commodity prices, energy prices, and VAT hikes. The liquidity squeeze is afoot.

Rebecca Wilder

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It’s pretty simple: the ECB’s now in hiking mode

I WAY underestimated the simplicity of ECB policy. I think that the terse monetary policy objective explains quite well the ECB’s announced stance on policy today:

The primary objective of the ECB’s monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term.


Today the ECB announced that it would keep the refi rate unchanged at 1%, however, Trichet made it quite clear that rate hikes at the next meeting cannot be ruled out (rather should be ruled in). The market response was pretty strong: bond markets are now pricing in 75 basis points of rate hikes this year, which would take the refi rate to 1.75% by the end of 2011; the euro’s close to breaking the 1.40 mark; and the 2-year yield is 13 basis points higher on the day.

The trigger, in my view, was the ECB’s increased inflation projection:

The March 2011 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation in a range between 2.0% and 2.6% for 2011 and between 1.0% and 2.4% for 2012.


The fact that the ECB is now projecting 2012 inflation upwards of 2.4% , which exceeds by leaps and bounds their 2% target in ‘ECB talk’, implies that the committee sees the medium-term outlook on inflation as seriously biased toward the upside. For the ECB, this means policy is way too accommodative.

Let’s step back a moment, though. Despite the ‘strong’ growth in the Eurozone, Germany, the largest Eurozone economy, has not fully recovered it’s GDP lost during the recession. As of Q4 2010, GDP remains 1.4% below its 2008 peak.

In my view, the ECB’s policy objective is too simplistic. During times of supply-side inflation shocks to food and commodities (i.e., wheat droughts or Middle East unrest), headline inflation overestimates the true impetus to prices.

Core and service prices are still very muted, while it’s goods prices that’s driving the price spikes.

It’s up to global growth now to see Eurozone growth through further. Better put: the Eurozone remains overly exposed to global growth shocks.

Rebecca Wilder

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Trichet and King: it’s energy, VAT, and food!

The global inflation picture is heating up. On Google, a search of ‘inflation’ spanning the month of February 2011 gets 311,000,000. For one year ago, the same search parameters yielded 1,850,000 hits. Inflation’s on the monetary policy makers’ minds. But why? In the developed world, it’s a food and energy story!

Seriously, look at German and US inflation since the 1960’s. Furthermore, check out core price pressures:

US 0.95% in January 2011…

…Germany 0.77% in January 2011

Dear Trichet, King, and part of the US FOMC: it’s energy and food….energy and food….energy and food…and VAT! David Beckworth writes a great piece about the merits of inflatin targeting.


Wheat, corn, soybean, and sugar prices have surged, whose price gains are now sitting very much on the back burner to oil prices. But look, wheat, soybean, and sugar price pressures are coming down. Therefore, food prices are showing signs of peaking. This should be taken into account when the ECB and BoE meet this week and next, especially if gas and fuel prices start to hinder economic growth prospects.

Some evidence:

* In the UK, price pressures are ever-present – the diffusion is much higher than in other European economies – but it’s very likely that prices peak. The economy’s been hit by a VAT hike twice in the last two years, and the depreciation of the nominal exchange rate continues to pass through to prices. Fiscal austerity will drag aggregate demand and prices – just hold on.
* In Germany, the domestic measure of consumer prices is expected to mark a 2.05% annual pace in February (1.96% in January), but the core level is growing a just a 0.77% annual rate (in January, which the latest available data point). For now, and probably throughout the rest of the year until union contracts reset on an aggregate level, it’s really all food and energy there.
* And in the US, core inflation is rising, but that’s primarily based on the re-emergence of the micro-pressures that are owner’s equivalent rent AND food and energy. Core inflation is now rising again (see recent Calculated Risk article), however, in my view, there’s not enough leading evidence to suggest that inflation expectations have in any way become unmoored. Unit labor costs, for example, remain submerged below a sea of economic profits (more on that tomorrow – but you can see a previous post on the subject here).

Watch monetary policy closely. The oil inflation may simply be the straw that breaks the camel’s back for some, since food prices have been headed north for some time. Key central banks shouldn’t hike – UK and ECB are notable examples – but they may.

I, consequently, still ‘hope’ that the recent hawkish rhetoric coming out of the ECB is simply a reflection of the hole that is the appointee to run the ECB after Trichet leaves in October. More bluntly put: they’ll say anything to get the job. (See Eurointelligence’s case for Mario Draghi.)

Rebecca Wilder

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Based on the German inflation print, the ECB may be less ‘hawkish’ next week than people think

Today the German Federal Statistics Office reported that the February Consumer Price Index is expected to mark a 2.0% (2.047% by my calculations, which is very close to a rounded 2.1%) annual pace in February 2011.

This is simply a ‘flash’ print, and the Statistics Office was very careful to discount the fact that inflation continues to be driven by energy. But the harmonised index of German consumer prices (HICP) increased a greater than expected 2.2% over the year, suggesting upward pressure to the headline Eurozone rate remains in play. Market participants are expecting ECB rate hikes this year – there are currently at least 2 hikes priced in through this year – based on an elevated Eurozone inflation rate, currently estimated at 2.4% in January.

The ECB is a devout inflation targeter (see first chart of this post); it’s a central bank that raised rates late in 2008 only to see Eurozone inflation plummet as the economy dropped into recession (see chart below). But I think that the ECB will be less hawkish than expected next week, because I’m noticing an interesting correlation between German-based inflation (supposedly not relevant, per se, to ECB policy), Eurozone HICP inflation (the ECB’s target rate of inflation), and the refi rate.

(Note that the ECB targets a weighted composite of harmonised index of consumer price inflation (HICP), rather than a composite of the domestic price indices. You can read about the measurement differences between domestic CPI and Eurostat’s Harmonised CPI here.)

The chart illustrates the German CPI, the German harmonised measure of the CPI (HICP), Eurozone HICP inflation, and the ECB’s policy rate. There are three things that jump out at me as relevant for ECB policy expectations: (read more after the jump!)

(1) The correlation between Eurozone HICP inflation is stronger with domestic German inflation (CPI) than with the German harmonised measure of inflation: 59% vs 88%, respectively.
(2) Related to number (1), the ECB policy rate appears to be driven more by the domestic measure of German inflation (CPI) rather than its harmonised measure. At least in the 2008 energy bubble, the German harmonised rate of inflation was falling well before the ECB hiked the refi rate.
(3) Therefore, it is possible, that with German CPI printing at a lower rate than the harmonized measure, currently 2.05% vs. 2.23%, market participants who expect a very hawkish ECB statement next week may be disappointed (the ECB announces its policy rate next week).

The exact reason for (1) is worth exploring.

Rebecca Wilder

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