European Central Bank: Time to Phase Out Liquidity Programs

By David Parkinson

The U.S. Federal Reserve Board is having a bit of trouble finding the exit. Not so the European Union’s central bank.

The European Central Bank announced Thursday that its “extraordinary liquidity measures” (read: quantitative easing) put into place to stave off a major economic failure are “no longer needed to the same extent as in the past,” and as a result will be “phased out in a timely and gradual fashion.”

The euro initially surged against the U.S. dollar on the news, which is in stark contrast to the position the Fed communicated on its own liquidity measures in its Wednesday monetary policy statement.

The Fed did trim its program to buy agency debt by $25 billion (U.S.), to $175 billion, but acknowledged that this was largely because there just wasn’t enough of the debt out there in the market for it to buy. The reduction represents a mere 2% of its program to purchase agency debt and mortgage-backed securities. The Fed also didn’t announce any new plans to buy U.S. government paper, after its previous $300 billion program was completed in October.

Still, the Fed said it “will continue to employ a wide range of tools to promote economic recovery and to preserve price stability.”

Translation: At least publicly, the Fed isn’t ready to espouse an exit strategy from its aggressive, crisis-driven monetary policies – much less actually head for the exit.

The ECB, by contrast, is pointing to the door and saying, “That’s where we’re going, follow us.”

That distinction should be supportive of the euro and higher European bond yields. It also implies that the euro economies are well ahead of the United States on the economic-recovery path – which is bullish for European equities.

Comments

[Davewmart:]

The stresses wtihin Europe are likely to increase.
France is heading out of recession, and Germany is not doing too badly, which has perhaps driven the ECB's stance.
Countries like Spain and Italy are however deep in recession, and reduced liquidity is likely to hit them hard.

Nov 05 05:59 PM

[manya05:]

Europe felt the shock of the collapse in the US (and concomitant drop in world trade), but their economies were (and are) essentially sound. A very diversified economy, with a good balance between internal consumption and exports, and a very broad base spanning from agriculture to manufacturing and services. With the exception of the UK (heading to bankruptcy), and some countries in Eastern Europe (too new to the EU to fully capture its benefits), the rest of Europe is already over the hump and well on its way to a healthy recovery. No worries.

Nov 05 10:00 PM

[JeffDB:]

The big question is when the Fed may begin to make a move. They can certainly move markets in a big hurry:

Central banks chill asset rally
29 Oct 2009
www.telegraph.co.uk/fi...

The liquidity tide is turning. Authorities across large parts of the world have either begun to tighten the spigot or are taking steps to wean their economies off emergency stimulus. This is a treacherous moment for markets.

... Teun Draaisma, Morgan Stanley's equity strategist, said investors should move with care as central banks awaken. A study of 19 "bear market" rallies over recent decades shows that bourses tend to tip over as the US Federal Reserve starts tightening. Equities fall back 25pc over the next 13 months on average. It is unlikely to be better this time.

"Given the amount of leverage in the economy, little changes in rates can have a disproportionate impact. The poor state of government finances, the high supply of bonds, and the fear of inflation could further exaggerate a bond market sell-off once tightening starts," he said.

Timing is tricky. Stock markets began to fall four months before the first rate US rise in 2004, but they did not tip over until the tightening started in 1994.
...
Even so, markets are skittish. Fears of "shock therapy" from the Fed are rising after a string of comments by Fed hawks (not Ben Bernanke) hinting that rates may come sooner and harder than expected. There is little doubt that the spike in yields on 10-year US Treasuries above 3.5pc on Monday - rasing the benchmark cost of money for the global system - was a trigger for Wall Street's sell-off this week.

Funds are fretting as the Fed winds down its programme to cap bond rates through "credit easing". The $300bn (£181bn) blitz on Treasury debt ended yesterday: the $1.25bn purchase of mortgage debt expires in March.

Rob Carnell from ING said the Fed risks a serious error if it backs away from its pledge to keep rates ultra-low for an "extended period", as rumoured. "The phrase is dynamite. It should be handled with extreme caution," he said.

John Higgins from Capital Economics said the Fed soaked up 39pc of the total $719bn in net debt raised by Washington between April and September. "With vast quantities of issuance still required for financing the budget deficit, investors are nervous," he said. The hope is that commercial banks will fill the Fed's shoes.
...
China's bank regulator curbed consumer loans this week. Qin Xao, head of China Merchants Bank, said the country's property and stock markets are in danger of spiralling out of control after loan growth of $1.27 trillion over the last nine months. "It is urgent that China shifts from a loose monetary policy stance to a neutral one," he said.

The core problem is that near-zero rates in the West are too low for the catch-up economies of the Pacific region, Mid-East, and Latin America. Dollar liquidity is sloshing through the emerging world. This is what happened in the early 1990s when Fed stimulus caused Mexico and others with dollar pegs to overheat, leading to the tequila crisis two years later. The scale is greater this time.

Beijing may soon find that the advantages of holding down the yuan to gain export share - "stealing jobs", says Nobel economist Paul Krugman - is outweighed by loss of control over prices. Variants of this story are occurring in over 40 countries linked to the dollar.

There was a time when it was enough to watch the Fed and Europe's central banks for clues on the global credit cycle. Now we must pay close attention to Asian and Latin tigers as well. They are already growling.

Nov 05 11:44 PM

[JudeJin:]

soros summarized it very well: the central banks will let go and brake, and so on...until something drastically different is required.

Nov 05 11:47 PM

[tripleblack:]

I think that folks in Iceland, Ireland, Spain, Italy, UK, and (as you yourself point out) "some countries in Eastern Europe " might strongly disagree.

There are 2 EU's now, assuming Germany is doing better than they appear to be doing and can be lumped in with France.

Whether the banks can follow two financial policies simultaneously is the quesion...

I think not, in which case the winners will be supported, and the losers will have to just lump it.

This process could get bumpy and noisy, though.


On Nov 05 10:00 PM manya05 wrote:

> Europe felt the shock of the collapse in the US (and concomitant
> drop in world trade), but their economies were (and are) essentially
> sound. A very diversified economy, with a good balance between internal
> consumption and exports, and a very broad base spanning from agriculture
> to manufacturing and services. With the exception of the UK (heading
> to bankruptcy), and some countries in Eastern Europe (too new to
> the EU to fully capture its benefits), the rest of Europe is already
> over the hump and well on its way to a healthy recovery. No worries.

Nov 07 08:11 AM