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.