The Eurozone credit impulse

Tomorrow's ECB meeting comes at an interesting time, both for policymakers and for markets.  For the ECB, the Fed's apparent retreat from its 2015 liftoff conviction (at least in the eyes of markets) is something of a mixed blessing;  while it will presumably prop up business confidence and provide marginal support for global growth (a good thing for the C/A surplus Eurozone), it may also bolster the euro exchange rate which is decidedly not what the doctor ordered for Europe.

Markets, meanwhile, have kind of assumed that the ECB would progress to a further round of easing, particularly after the forecast downgrades last month.  However, recent comments appear to have pushed back a bit against notions of an imminent easing; given the relatively high expectations (though not necessarily for this week's meeting), there is room for disappointment.  To be sure, Bunds had a bit of a rough day yesterday, though that may have had as much to do with reported Asian CB selling as it did with the ECB.

Eonia, meanwhile, remains at an appropriate level (-14 bps) given the depo rate (- 20 bps) and the amount of excess liquidity (~500  billion euros.)   Forward Eonia remains priced for another depo rate cut if anything; 1y1y is just 4 bps off of the depo rate, which is a tiny margin even by the standards of the last couple of years.

If (and it's a big if) Draghi pooh-poohs the outlook for further easing, it seems reasonable to expect a 5-10 bp backup in 1y1y.  Of course, once you factor in bid/ask spreads and haggling over tear-up fees, it's hard to argue that there's any sort of trade there.

Taking a step back, Macro Man noted in the equity piece on Monday that an improved credit impulse in Europe was one reason for optimism.  MFI loan growth to non-financial corporatons has finally turned positive....


...though not as positive as the pick-up in consumer credit, which notable did not enjoy any sort of short-lived renaissance in 2010-11.

The reasons aren't hard to fathom.  Although far from pristine, many banks in Europe have improved their balance sheets; this, combined with ample support (nay encouragement!) from the ECB, has improved their capacity to lend.   The impact can be seen in the rates charged, as evidenced by the bank loan rate series from the Banca d'Italia.


Why it matters for equities is that earnings of the Eurostoxx 50 have been very strongly correlated with overall loan growth in the euro area.


Of course, this nascent pick-up is still more acorn than oak tree, which is the argument in favor of the ECB keeping its foot planted firmly to the accelerator (while hoping to minimize dodgy VW-style emissions.)  As many readers are no doubt aware, implementation is becoming a challenge, given the 33% limit on individual bond holdings (25% for those with CACs.)  For these reasons, Draghi's comments on Thursday will be parsed unusually closely to see which way the GC is leaning: depo rate cut, more QE, or standing pat.

Squaring the circle, does more bank lending imply higher bond yields?  Theoretically yes, as banks sell securities to clear room for higher yielding loans on the balance sheet.   However, with the ECB as a major buyer, there is little reason to expect that any bond sales for the purpose of lending (which at this juncture is probably premature anyways) to have a substantial market impact.  Moreover, the empirical evidence from the US suggests little correlation between loan growth and bond yields, even before QE:


It may well be that European bond yields rise, simply because there isn't that much room for them to fall further.  (5 year Germany at zero yield?  Pass.)  However, if and when it happens, it probably won't be bank lending that spurs it; over the next year or so, something tells Macro Man it won't be the ECB either.
Previous
Next Post »

19 comments

Click here for comments
Booger
admin
October 21, 2015 at 12:05 PM ×

Draghi, I suspect has no compelling need to increase QE currently but the groundwork is being laid in case this is needed later.

I think many of the current market questions centre around the truth value of one pressing question : is there an imploding real-estate bubble in China ?

If there is then other questions such as: has the HY/CCC credit market turned, will the Yuan devalue further, will there be further QE euro and QE Japan become self-evident. If there is not then we may well have seen an EM and resources bottom and risk assets can rally further.

For my part I think there is significant evidence that there has been a real estate and debt bubble in China. The magnitude of this is seen in the wave of peripheral effects on high end property virtually everywhere and property bubbles in Canada, Australia, New Zealand and probably other places.

The rapid growth in debt in China since 2009 is stunning and growth has clearly peaked which usually ends with an ugly crash and debt problem of some sort. Couple this to the usual developing country middle income growth plateau and even the base case scenario must still be worse than what the market is discounting.

Probably the best way to find out the truth value of this is to send a property expert with a good macro background to China and report back...

Reply
avatar
washedup
admin
October 21, 2015 at 12:59 PM ×

"Probably the best way to find out the truth value of this is to send a property expert with a good macro background to China and report back..."

Wish it were that easy - half of them happen to drive by a newly constructed site on a saturday morning and proclaim it to be a ghost city, and the other half will find themselves in a mall in shanghai on new years day and turn into drooling idiots.

It is a massive complex economy with no great way to sample. I have a hunch this is one of those 'reflexive' problems where if the financial world convinces itself that China is heading for disaster it will become self fulfilling, but with a slower fuse than usual, and vice versa. As an example, If oil manages a 60 handle on issues that have nothing to do with global demand, China sentiment and ultimate outcome will improve.

Reply
avatar
Booger
admin
October 21, 2015 at 1:42 PM ×

As we ponder this question, it looks like aud.usd has resolved lower out of a wedge over the last week, which sees me enter short there. Interestingly spoos continues to power up.

Reply
avatar
Polemic
admin
October 21, 2015 at 1:55 PM ×

I'm actually wondering if Aud is a buy. We are all focused on mining but last night's leading indicators showed other sectors are alive and kicking. It's certainly been discounted as a basket case, but a basket case with a yield.

Reply
avatar
Booger
admin
October 21, 2015 at 2:14 PM ×

Pol: which leading indicators were you referring to? AU, I tend to think to short it because of interest rate expectations. There are rumors the RBA may cut rates by 0.25% next month because Australian banks have had to increase interest rates by 0.2% recently due to increased capital provisioning requirements. The leading indicators such as retail sales and auction clearance rates in Sydney and Melbourne seem to have peaked so there maybe more room for the RBA to move. A case of trade the rumor on AU monetary policy. Oil going lower would be a bonus as would be any further China related turbulence.

Reply
avatar
Anonymous
admin
October 21, 2015 at 2:43 PM ×

Booger: Only Westpac increased by 0.2%, the others are likely to but have not confirmed yet.

Reply
avatar
Anonymous
admin
October 21, 2015 at 5:17 PM ×

Booger: The resiential real estate market in China is so fragmented that I do not think that anyone has an idea how big the bubble is, or if the bubble has bursted already. In cities you never heard of, developers are struggling. But is the risk of downfall really systematic and imminent? Judging from Shibor, it isn't.

The commercial real estate is a different story. Real estate market for retail is entering a downtrend: online shopping surely killed lots of brick and mortar retailers. And someone at the used-to-be busy shopping district in Shanghai will tell you that China is doomed because he is going to see so many closed/closing stores. But fine dining restaurants (not the high end ones) and coffee/tea houses are prospering, because of rising demand and falling rents.

Now, I do not think that real estate is the key here. Local government debts and shrinking tax revenue this year are more likely grab the headline this year. From what I heard, tax collection becomes a big headache and the fiscal revenue of the central government faces great difficulties. I agree that RMB is going to depreciate again, but the key is timing.

As of spoos, around this time every year I heard the same discussion on hedge funds needing to chase the market to make up their performance. Is it any different this year?

Reply
avatar
Polemic
admin
October 21, 2015 at 5:31 PM ×

From what I gather re HFs they ae on the sidelines til year end having been caught up and having had one big names fail they are under no pressure to outperform a outperforming ins surviving and surviving is not piling on risk into the year end.

My interest is actually all these real money funds being cited in the likes of BAML serves and CS surveys as underweight and bearish yet getting ground out with this steady up move. Their performance vs benchmarks must be looking pretty crappy. Those that hedged with options are seeing vol erosion as well as directional creep against them making them not look too chipper either.

Today has been a tad whip in the intraday. 2022-40 sex and 70+/- ftse swings. High itreaday usually points to near resolution. but but but ..

Personally I've got far too much upside risk on considering the state of play.

Pol

Reply
avatar
Mr. T
admin
October 21, 2015 at 5:53 PM ×

Not to derail an otherwise constructive thread but I see the whole China RE bubble as a bit of a canard. Is US defense spending in a bubble? Because I think that is the right way to look at the situation. The US defense budgets employ engineers and scientists and entire supply chains of readily available US based employees with probably modestly positive ROI's. The constant build/rebuild supply of chinese development by quasi state run organizations employs an army of laborers and civil engineers and govt bureaucrats with in the end probably similar ROI's to the US defense budget.

Reply
avatar
abee crombie
admin
October 21, 2015 at 5:55 PM ×

Agreed with the comment that China is too huge to simplify easily. J Capital has been pretty good on China, as well as CLSA, if you want to keep up without putting someone there ;-). Tier 1 cities, I dont think have any more bubble than say NYC, London or Paris. It is and will always be expensive. China has something like 170 cities with over 1M people, compared with only a dozen or so for the rest of "emerging asia" like Indonesia etc. That is where the bubble is for sure. Easy plays, like shorting iron ore etc have played out IMO (though I am not a buyer of VALE equity anytime soon).

As for Vancouver and Sydney housing, well if china get serious on capital controls, watch out, if not, I have no idea. They are still cheaper than London, NYC and Moscow, and better places to live (less exciting but better quality of life) so who knows

Reply
avatar
DownWithTheBeanCounters
admin
October 21, 2015 at 6:14 PM ×

Would someone please take a moment to explain to what extent the CNY is subject to market forces and to what extent it is managed? Much obliged

Reply
avatar
abee crombie
admin
October 21, 2015 at 6:44 PM ×

CNY is subject to capital inflows and outflows.

VRX (down 40% today) only adding to the hedge fund hotel names that are getting killed this year. The redemptions will be coming ;-)

Reply
avatar
Anonymous
admin
October 21, 2015 at 7:43 PM ×

Citi Expects Imminent Easing From Central Banks Of China, Australia, Japan And Europe.

Reply
avatar
Macro Man
admin
October 21, 2015 at 11:05 PM ×

@DWBC, There are four levels to China's exchange rate.

The daily reference rate, ie the PBOC fixing, is nearly 100% managed, ostensibly against a basket of major and regional currencies. While day-to-day changes in the reference rate are in many ways a function of the movement in the basket, in reality PBOC allows the fixing to trend based on policy decisions...i.e. a 5% gain versus the USD in year x, a 3% devaluation in August, etc.

The CNY onshore FX market deviates on an intraday basis based on supply and demand, albeit with theoretical limits: the FX rate is not allowed to deviate more than 2% from the central parity each day. In practice, the PBOC usually smooths things so that the daily deviation is way, way beneath the limit.

The CNH market is an offshore spot market over which PBOC theoretically has no control. As such, it has tended to be more volatile than the onshore market and subject to bigger swings, driven by supply and demand. In practice, however, PBOC uses agent banks to intervene in the CNH market when it wants to effect a certain price movement.

BTW, each of these markets is subject to varying degrees to "macroprudential" measures from PBOC, i.e. forcing banks to take large margin (that pays no interest!) on FX transactions, etc.

Finally, there is the NDF market, which is traded by foreigners outside of China, but which settles into the CNY fixing rate. These forwards can trade wherever they want, subject to market supply and demand....but are also the subject of arbitrage flows from banks with an onshore presence, so in reality do not totally decouple from the CNY/CNH market.

Now, theoretically the PBOC cannot intervene forever, so ultimately a persistent capital outflow could force them to abandon smoothing/intervention. However, they do have an enormous warchest of reserves and ample room to cut the RRR to sterilize the intervention impact on the domestic money market.

It is my view, therefore, that they can maintain a largely managed FX rate for a considerable period, particularly as the C/A mitigates some of the capital acct outflow. Others are less sanguine, though in my mind they are conflating "what will happen" with "what ought to happen."

Reply
avatar
NoE
admin
October 22, 2015 at 12:27 AM ×

Few things to add..
AUDUSD is a lifestyle short for many so constantly subject to short-squeezes from late-comers. It will go down as RBA's hand will be forced (not Nov but probably Feb16). They have been waiting lift-off from the FED to bring the CCY down but are running out of time and patience and yes Westpacs 20bp rise in mortgage rates last week is going to make them more anxious (other banks will need to follow suit - just waiting for the right political cover).

Heard that yesterdays Bund/UST selloff was on the back of the 4.75bn 2065 GILT issuance and that old harbinger of doom, "liquidity" meant that UST/Bund futs were the hedging weapon of choice.

Read Matt King's latest piece. Tells you all you need to know about the upcoming storm in global risk assets. Not sure of the tipping point, but everything I hear from credit traders is that things haven't been this dire in liquidity terms "since 2007".

Reply
avatar
Leftback
admin
October 22, 2015 at 1:36 AM ×

This is no time to have any kind of size on, long or short. Long-term positions are one thing, but if anyone claims to know what is going to happen in the next few weeks, I will show you someone bending over.

MM, mate, you are really making good use of that brand spanking new Bloomberg you had delivered :-)

Reply
avatar
Mr. T
admin
October 22, 2015 at 4:57 AM ×

The charade in Europe with the ECB continues. They always seem like pivotal meetings, but the tenor of the conversation up to the meetings seems to have changed. We used to talk about the fed put in a sortof dirty way, now markets appear clearly in control and if not demanding more policy at least feeling entitled to it. I suspect the Kabuki will continue with Draghi sounding optimistic about policy efficacy while at the same time acknowledging that the current dosage was inadequate. To this punter its getting a bit silly.

Reply
avatar
DownWithTheBeanCounters
admin
October 22, 2015 at 2:19 PM ×

MM: Thank you for the run through- very much appreciated. When I type CNY Curncy there are a lot of options.

Reply
avatar
Sets Shaibu
admin
October 27, 2015 at 11:01 PM ×

I GOT A FAST APPROVED LAON @ 2% INTEREST RATE

I am married with two kids and i was stuck in a financial situation and i needed to refinance, pay debt and pay for my husband medical bill. I tried seeking loans from various loan firms both private and corporate but never with success,and most banks declined my credit. But as God would have it, i was introduced to VICTORIA LAWSON LOAN FIRM by a friend and i applied immediately with {marianlawson@outlook.com} loan sum of $30,000USD and today am a business owner and my kids are doing well at the moment. So dear,if you must contact any firm with reference to securing a loan with low interest rate of 2% and good repayment plans, Contact Victoria Lawson Loan Firm with (marianlawson@outlook.com) I am so happy now and i decided to let people know more about her, she offers all kinds of loans. You can contact her company today

*Full Name:_________

*Address:_________

*Tell:_________

*loan amount:_________

*Loan duration:_________

*Country:_________

*Purpose of loan:_________

*Monthly Income:__________

*Occupation__________

*Next of kins :_________

*Email :_________

Reply
avatar