The Benefits Already Sparse On The Plus Side, Europe Flirts With Widespread NIRP

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Includes: ADRU, DBEU, DBEZ, EEA, EPV, EURL, EZU, FEEU, FEP, FEU, FEUZ, FEZ, FIEU, HEDJ, HEGE, HEZU, HFEZ, HFXE, HGEU, IEUR, IEV, RFEU, SBEU, UL, UPV, VGK
by: Jeffrey Snider

Summary

The ECB has been moved to further emulate the Bank of Japan and buy increasing amounts of more asset varieties. That includes the big splash made last month when the ECB clarified details of its corporate bond buying program to begin in June.

Bloomberg estimated that €14 billion of the highest tier of corporate bonds were already trading in the secondary market with negative yields; their inference was that it is likely only a matter of time before negative nominals are tagged to primary issuance. Unilever's bonds show that isn't quite the case yet, but the European corporate market is certainly flirting with the possibility.

What Unilever actually shows us is the absolute circus of monetary policy that just goes nowhere; the company is being further penalized by its increased holdings of cash, only to have that offset by lower yields in the debt it sells to the "market" stripped of liquid alternatives by QE and whatever else the ECB will dream up next.

The very fact that liquidity remains the top priority even now in Europe (as Japan) shows conclusively that QE can never work; QE has always been about expectations, and by now, the only expectations that are being affected are financial firms and even productive corporate businesses betting on only more of it.

By Jeffrey P. Snider

Unilever (NYSE:UL) is a rather typical multinational conglomerate trying to weather this "recovery" as best as it can. It is, of course, quite jarring to realize that any business so positioned might have to "weather" any recovery, but that is the state that it is presented with. Reporting Q1 results last week, the company improved slightly to almost 5% in underlying sales growth. That was slightly better than 2015 overall, just 4.1%, but still well below Unilever's historical average.

There aren't many places where Unilever can extract price increases to offset very weak volume growth. For CY 2015, volume growth was just 2.1%; in Q1, it barely rose to 2.6%. Almost all of the gains in pricing were due to Latin America and really Brazil. Volume growth in Q1 was just 1.1% in the Americas geographical segment, but prices added another 7.3% to the underlying sales growth of 8.5% total.

By contrast, in the North American segment alone, there was neither volume nor price growth (-0.1% volume; +0.1% prices), adding more anecdotal evidence to the catalog increasingly stacked against the employment statistics in the US. In Europe, we find only the ECB's nightmare scenario: volume growth remained slow at 1.8% in Q1, but prices in Unilever's terms fell 2.4%, yielding -0.6% in sales growth. As the company noted in its quarterly presentation:

There was strong underlying price growth in Latin America and virtually no price growth in Asia. Developed markets declined by 0.3% with volume growth offset by widespread price deflation in Europe. [emphasis added]

From an orthodox perspective, you can appreciate why the ECB has been so moved to further emulate the Bank of Japan (while apparently refraining from offering explanation as to why the ECB might be able to be successful with these measures, where the Bank of Japan clearly has never been) and buy increasing amounts of more asset varieties. That includes the big splash made last month when the ECB clarified details of its corporate bond buying program to begin in June.

The idea is "portfolio effects" coupled with lower interest rates that are supposed to filter down to smaller and medium enterprises (SMEs). By buying corporate bonds, the ECB expects that financial agents will have no choice but to add risky positions including loans to SMEs that it believes could just use more debt. One immediately stands in awe of the total convolution of the scheme, setting aside any rejection of additional borrowing and credit as the solution here, as if distorting now the corporate sector to join the ridiculously skewed financial sector has anything more than the slightest chance of actually drawing out the intended results.

For its part, Unilever today is taking advantage of the ECB's intended redistributionary beneficence by offering three new bonds at staggered four-year maturities. The first tranche is a four-year zero but issued at barely any discount in face value, meaning the calculate yield is a rounding error of 0.06%. It won't be long before these corporates join sovereigns below the zero lower bound. At the end of March, Sanofi (NYSE:SNY), France's largest pharma company, sold bonds at the then-lowest yield on record. At that time, Bloomberg estimated that €14 billion of the highest tier of corporate bonds were already trading in the secondary market with negative yields; their inference was that it is likely only a matter of time before negative nominals are tagged to primary issuance. Unilever's bonds show that isn't quite the case yet, but the European corporate market is certainly flirting with the possibility.

"Is there any reason why investors won't buy corporate bonds sold with a negative yield?" said Denman. "I see no reason why they wouldn't. They may not like it, but it costs them to hold cash. So long as money remains in this asset class, then investors may feel they have little choice."

That is ultimately the issue here, as the ECB is not creating risk or igniting "animal spirits" but merely handing out liquidity subsidies to anyone with the "right" kinds of characteristics. Unilever, for its part, hasn't used any such "cheaper" debt before to create actual productive activity. In May 2015, the company issued €750 million in floating rate notes maturing June 2018 (not exactly betting on QE's success) and €500 million in 1% notes with an eight-year maturity (June 2023). The company also floated $1 billion in dollar-denominated bonds at 2.1% (2020) and 3.1% (2025).

The proceeds of that increase in debt helped fund €1.9 billion in acquisitions (M&A) and the increase in total dividend payments (from €3.19 billion in 2014 to €3.3 billion in 2015). What did not increase in 2015 was capex; total capital expenditures last year on a cash flow basis (€1.867 billion) were slightly less than the year before (€1.893 billion). The company also raised its carrying cash balance; €1.547 billion in cash plus €655 million in short-term deposits at the end of 2015 compared with €1.390 billion cash and €540 million in short-term instruments at the start.

As we have seen everywhere, companies take prudent liquidity measure by holding cash balances in larger amounts where debt balances rise. That means these companies are going to be consistent buyers of negative yielding money market assets (or even shorter-duration sovereigns) no matter how much pressure the ECB enforces via NIRP and QEs. Even in European money market funds that are already costing investors yield just for participating, large corporate cash needs remained largely steady even as the ECB pushed further into NIRP, taking money markets right with it.

Money market funds in Europe that can no longer return all your cash remain popular with companies due to a lack of alternatives, even if an era of increasingly negative interest rates may demand a broader rethink of cash management.

If there is to be any "rethink," it must be on the part of central bankers and their loose and slipping grasp of the real world. What Unilever actually shows us is the absolute circus of monetary policy that just goes nowhere; the company is being further penalized by its increased holdings of cash, only to have that offset by lower yields in the debt it sells to the "market" stripped of liquid alternatives by QE and whatever else the ECB will dream up next. In other words, risk is altered in qualitative fashion to only changing costs and relative conditions of liquidity preferences. This is occurring not just in corporate cash holdings, but financial as well (deeply negative Euribor all the way out in maturity as well as Eonia). And at the end of it all the ECB just expects that this Rube Goldberg financialism will somehow benefit small businesses and European consumers.

To the current state of monetarism, "rational" action is to get out of negative yielding money markets and into something more risky to generate relatively better and positive returns. In the real economy, that isn't the likely first priority, especially when expected returns on even risky assets are next to nothing and getting more so with each intervention. The ECB is only contributing to its own downward spiral; the only way to make money is by anticipating what it might be that the ECB buys next (just like Japan). There is no actual move toward "animal spirits" because real economy participants just aren't as stupid as monetarists take them to be.

In the case of Unilever, they have no reason to suspect that monetarism works after having had to "weather" this "recovery" all over the world. Where the company has been most "successful" is again Latin America, in the utter collapse of Brazil, gaining about 18% in sales growth (only 2.4% in volume) in Q1 due to price changes as the people of Brazil are pushed only toward further economic depression. When those are your best results, liquidity and safety are the only priorities no matter how much more absurd central banks make them.

From Unilever's perspective, the company may even be grateful that the ECB would aid it in its issuance of more debt for liquidity, but that doesn't aid the economy and has only sowed increasing populist resentment, because it never goes any further than that; it is the worst kind of "trickle down," because there isn't even much trickle. The very fact that liquidity remains the top priority even now in Europe (as Japan) shows conclusively that QE can never work; QE has always been about expectations, and by now, the only expectations that are being affected are financial firms and even productive corporate businesses betting on only more of it. It isn't "stimulus" so much as increasingly complicated liquidity management, which only keeps the focus on liquidity management.

That much is sure as more and more assets are driven negative. At some point, you would think the ECB would realize that rather than negative rates being "stimulus," they are just as likely, if not more so, to be deflationary and depressive. Then again, the Bank of Japan has been at it for more than a quarter century, and everything they repeat is still called "stimulus" no matter how obvious the lack of results or the repeated incidences of harm. The more it becomes clear that central bankers will not stop themselves (and nobody seems even close to discussing the possibility of making them stop), the more global businesses of all sizes will increasingly have to devote resources to living under these conditions, hardening exactly all the wrong sorts of habits and priorities.