The Specter Of 'Rehnfeld' Falls Across The ECB's Monetary Policy Transfer Mechanism

by: Adam Whitehead

The ECB is considering whether its monetary policy transfer mechanism is broken.

“The Procrastinator” has become “Rehnfeld” in time to prepare the ECB for Shock and Awe.

A “Hail Mary” Incremental TLTRO III is intended to see the ECB through a Fed-style review of the monetary policy transfer mechanism.

TLTRO III is a tapering of the TLTRO program and thus a net tightening of monetary policy.

Deeper Eurozone integration (and Brexit or not) will be a sideshow if President Trump abandons NATO and tariff-free trade with the bloc.

(Source: Author)

The current debate, whether the current Eurozone slowdown is in a recession or not, is abstract and also misses the point. What needs to be debated is the kind of policy response required in the worst case scenario that it is a recession. Simply talking about the expected economic rebound is similarly pointless, in an environment in which any recovery would simply cause the global central banks to hit the brakes again with further monetary policy normalization.

(Source: The Daily Shot)

We should all be thinking outside the box. Fortunately, The Procrastinator is thinking What If? If is a question in relation to the It of the monetary policy transfer mechanism from the ECB to the real Eurozone economy. If It ain’t broke don’t fix It. If It is broken, however, then it’s time for some Shock and Awe.

(Source: Author)

Mr. Market thinks that the ECB’s recent re-heating of the emergency liquidity known as the TLTRO is a big deal. It is, but not for the reason that Mr. Market thinks. Contrary to belief, the ECB has foregone a serious attempt to address the current economic slowdown. It has done this because it wants the Eurozone to work its way through the current headwinds, under its own steam without monetary policy support, until it has figured out what is really going on.

Assuming that there is a problem, the ECB will respond with a proportionate monetary policy response. This proportionate response may or may not be even larger than the QE seen to date.

The monetary policy response to the current slowdown is thus a sticking plaster applied to the widening wound. The big deal is therefore that the ECB has knowingly elected to under-deliver in the short to medium-term. In the future, if the ECB is forced to Q-ease again, people will point back to the March Governing Council meeting as the singularity moment.

(Source: ECB)

The monetary policy making process at the ECB is Carthusian. First there must be cause, then comes effect and finally comes the ECB’s response. In line with this framework, the ECB began the process of responding to the current economic slowdown with a revised forecast for lower growth and inflation.

Some Governing Council members leaked in advance the disclaimer that even this lower forecast is too optimistic. The only conclusion to be drawn therefore is that the forecast was designed deliberately to fit the monetary policy response already agreed upon in advance. In the vernacular, the cart was put before the horse.

The forecast showed a substantial economic slowdown, with a slight dip in inflation, yet no return to recession conditions any time between now and late 2021. This is a nice holding tactic, with a nice holding period in which to review and come up with a strategic plan.

The signal is therefore that the ECB is neither going to normalize monetary policy aggressively on its original schedule, nor is it going to embark on a new phase of QE immediately.

Faced with the current global economic slowdown and Brexit, this is a "Hail Mary" from the ECB. Any deterioration in growth in the future, will swiftly nullify the forecast and the current policy decision allegedly taken because of it. The details of the policy changes, explained the components of the "Hail Mary" policy tool decision.

Interest rates were left unchanged, but communications announced a whole load of new measures that ostensibly appear to be a mixture of additional emergency funding and a push-back on normalization plans.

Interest rates are now expected to be on hold for the rest of the year. QE proceeds reinvestment and will be extended until interest rates rise.

In September, new emergency funding measures will be injected in the Eurozone financial system. At this time also, more details on the new emergency funding measure to be known as TLTRO III will be given. The vagueness of the details of the amounts involved in TLTRO III, speak of both the ECB’s uncertainty and its unwillingness to hazard a guess on how bad things are. The duration of TLTRO III will however be shorter, out to 2021, than previous TRLTROs. In principle, the TLTRO programme has been tapered. This is therefore a net liquidity drain, commonly experienced as a tightening of monetary policy when it occurs.

Rumors from the committee designing the TLTRO III program have showed a considerable variation in belief about its purpose and perspective.

There are those who wish to make it punitive, in order to wean the banks off reliance upon it. Such a punitive stick will come in the form of a high premium to the benchmark funding rate. This would be accompanied with a carrot of reduced scaled premiums for banks who use the funds to expand lending. There are also those who wish the funds to be injected at a discount in order to support the flagging banks. TLTRO III is therefore currently vaguely conceived. Such vague conceptions will detract from and undermine its efficiency and impact.

(Source: Author)

The committee battleground over the design of TLTRO III shows the traditional split between the Great Consolidators and the Consolidated within the Eurozone. The former would like to acquire their competitors in other Eurozone countries on the cheap. They would thus like a punitive TLTRO III. The targets, on the other hand, would like to be kept on life support so that they can evade capture by the Great Consolidators.

This squabble over TLTRO III may delay its inception. The consequences for the Eurozone economy and its banks will be dire if this delay transpires.

On balance therefore, monetary policy normalization has been delayed and then sustained with some incremental TLTRO. This incremental TLTRO is however a net tightening relative to previous ones. There is a distinct asymmetry between the scale of the economic headwind and the policy response. The scale of the headwind is much greater than the monetary policy response, hence the "Hail Mary" epithet.

(Source: Author)

ECB Governing Council member Francois Villeroy de Galhau, epitomized the hyperbole versus reality in guidance versus threat. Whilst failing to call the current slowdown a recession, he has now openly admitted that it is permanent and not temporary.

The situation is in fact so grave, that even the sado-monetarist Governing Council member Ewald Nowotny must abandon his flirtation with Austerianism. Suitably chastened, presumably by Mario Draghi and the industrial slowdown in Germany, Nowotny now believes that the latest ECB policy move sends an appropriate expansionary signal. As explained above this, is a "Hail Mary" fantasy and not even a dream.

Seemingly unaware that the latest truncated TLTRO III being offered is too little, Nowotny then snatched it further out of the immediate reach of the banks. According to his calendar, TLTRO III details are scheduled to appear in June rather than immediately. The banks don’t know what they will get but they know that it will be too late. Between now and then, they will therefore be aggressively cutting back their risk and lending exposure. Ironically, the TLTRO will be the catalyst for a deepening crisis rather than the prophylactic measure intended.

In consequence, rather than admitting failure by doing more QE, the ECB may have to boost the size of TLTRO III, IV etc etc to QE proportions. The ECB can thus pretend that the normalization is technically still on, since it hasn’t technically strictly speaking expanded QE. The current ECB vagueness, over the size of TLTRO III, speaks to this pretense. Ultimately however, there will be more easing once the monetary policy framework is completed during the TLTRO phase. What follows can’t be QE as we have known it. It will have to be some kind of Shock and Awe. More on this later.

(Source: Author)

Further QE and even QE proceeds reinvestment is encumbered by the new Capital Key weightings. This precludes the ECB from buying Spanish, Italian and French bonds as part of normal QE and QE reinvestment. The ECB may, however, try and fudge this limitation by using the TLTRO III program to buy them.

TLTRO III is the flexible tool by which the ECB can square the circle of Q-easing again whilst still promising to normalize first and complying with the new Capital Key rules. TLTRO III should thus be viewed as a tactically expedient fudge rather than a strategic monetary policy tool. Its strategic efficacy is in rule bending and bridging the gap to the next monetary policy expansion.

This is pure Mario Draghi practical genius at his best. It’s a pity he won’t be around for much longer. We shall miss him and his virtuoso Governing Council press conference performances. We hope that what comes next will be as entertaining. This may well be the case, as the reader shall soon see.

Governing Council member Vitas Vasiliauskas has maintained his creative sense of humor throughout the slowdown to date. His latest joke was to tell his assembled audience that the ECB is acting “pre-emptively” with its new policy stance. The ECB is thus acting “pre-emptively” to something that has been going on for a while!

The joke was exposed further when, even whilst saying that the move was “pre-emptive”, he then admitted that he was surprised by the ECB’s latest forecast revisions. The ECB is thus “pre-empting” a surprise! How a “pre-emptive” move can be a surprise, only he alone knows. Evidently the old German maxim that if you want a lie to be believed, repeat a big one frequently, holds strong with Vasiliauskas.

Vasiliauskas was not joking when he said that TLTRO III will not include mortgage backed securities (MBS) however. Any further weakness in the Eurozone housing sector, will thus be allowed to infect the banking sector and the Eurozone economy in general by default.

(Source: Author)

Executive Board member Yves Mersch also has a sense of humor and is earning his nickname of Inspector Clouseau. In an attempt to promote confidence, he contradicted himself with the conflicting visions of how and when the economic recovery will return. In his view, the persistence of the slowdown is unclear, yet the timing and strength of recovery is not clear either. Despite being clueless on both, he remains confident that a rebound will occur however.

Mr. Market unfortunately believes that the new ECB economic forecasts were optimistic lies. He therefore expects further downgrades to come. He also notes that the TLTRO emergency funding promised, which is less than the last program, will be insufficient to prevent problems for the Eurozone banking sector. The ECB therefore has not done enough to address the current slowdown or its future negative impacts on the Eurozone economy. In Vasiliauskas’ jocular terms, it has "pre-empted" the solution by creating a deeper crisis.

(Source: Author)

The ECB’s Executive Board has certainly adopted the comedic approach to guidance performed by Vasiliauskas and Mersch. Board member Benoit Coeure quipped that the new round of TLTRO easing is in fact not an easing at all. In fact it was always anticipated, at least by him. The only difference is that it has arrived a little sooner than expected in his opinion.

(Source: Author)

The joke is not funny. What it implies is that the ECB always expected the Eurozone and economy and its banks to get into trouble. It also does not anticipate saving the banks, so they will have to save themselves. Coeure is therefore articulating that the Great Consolidation in the Eurozone banking sector is no joke. It is a depressing certainty that the ECB will enable, by providing what it hopes will be just enough funding to prevent a wholesale banking crisis turning into a deeper recession that would require taxpayer funded bailouts and further QE. The ECB has thus seen a crisis coming and deliberately looked the other way, whilst proffering some jokes and a bit of liquidity to give the appearance that it is looking.

One must admire the ECB’s intestinal fortitude, even though it appears somewhat reckless. The current economic slowdown could easily become a recession of its own making. Nudging the banks into consolidating during this quasi-recession is very tough love indeed. Evidently, the ECB does not see any appetite for sovereign bailouts by ECB taxpayers. It has therefore set its stall out for that rare situation in the Eurozone, where a market solution to a structural economic problem is allowed to take its course.

This would be a risky undertaking if it was just a Eurozone matter. The problem is that there is a global economic slowdown underway, that is being driven by protectionism and trade wars. Oh yes and there is also Brexit to throw into the mix. The ECB will have no shortage of causes to blame, if its banking consolidation strategy does not play out smoothly. Said excuses then become the causes and justification for further QE if and when needed. Crisis remains the Eurozone’s main agent of change.

(Source: Author)

Coeure also had some words of warning, for the first intended victim of the ECB’s abstemious TLTRO III round. The last report noted the Italians moving to protect their banking system from being consolidated, by demanding that the ECB ease again whilst also threatening to nationalize the banks. The methods employed by the Italians were crude. The French banking system and economy is hostage to Italian economic fortunes, based on its large economic exposure to the nation. Italian policy-makers have therefore leveraged this French weakness.

Coeure attempted to walk-back the perceived threat to France. Speaking to a largely Italian audience in Milan, he opined that Italy is only a threat to itself and not the Eurozone in general. His words have simply raised the stakes and will prompt the Italians to raise the rhetoric to see where the real contagion fault-lines are. Evidently the French are worried, because Bank of France Governor Francois Villeroy de Galhau is considering raising reserve requirements as French bank lending is far in excess of GDP growth.

Slovenian ECB Governing Council member Bosjan Vasle would seem to have a more realistic perspective on matters than the jokers. He identifies the twin evils of global trade wars and Brexit as significant risks to the Eurozone. He won’t hazard a guess, to the severity or duration of the current slowdown, but it is clear that he does not see a temporary situation. For him, this is the beginning of a slowdown. In the face of these challenges, Vasle also promotes the Great Consolidation in the banking sector to withstand the economic headwinds through scale.

(Source: Author)

Outgoing ECB Chief Economist Peter Praet is the biggest joker of them all. His latest joke is a segue allusion that practically gives away the ECB’s next project. This project involves the attack on crypto-currencies, in order to create a Crypto-Euro that the central bank can digitally debase as an alternative to ZIRP/NIRP. It has already been blessed by the IMF, which is the global repository of SDR’s. Crypto-SDR’s will therefore be on the cards too, to nudge the project globally.

(Source: investinblockchain)

Praet jokingly tweeted that the ECB can create money to buy assets. The Tweet was however a declaration of digital intentions and capabilities rather than the joke that it was interpreted as.

(Source: Author)

Governing Council member Ollie Rehn has signaled that he intends to have the last laugh over his colleagues and also this author. Having enjoyed referring to him as The Procrastinator, this author has to face the reality that Rehn may soon be anything but that. His procrastination has evidently served his purpose of being the stalking horse to replace Mario Draghi as ECB President. His new character “Rehnfeld” is long overdue, but most welcome. This implies that the easing anticipated from him will have to be more substantial and meaningfully different than QE to date when it eventually appears.

(Source: Author)

One could look to Japan and the BOJ for inspiration. Presumably Rehn has done so. He will also have noted were Japan failed, most spectacularly with the seizing up of its banking sector. In addition to removing negative interest rates, Rehn could therefore target the yield curve aggressively as previously suggested by this author.

As the prize is within reach, Rehn has shed The Procrastinator costume and spoken like the next ECB President. His words are strong and evince similar intentions and capabilities to undergo the kind of policy framework reform currently being undertaken by Chairman Powell over at the Fed.

Rehn has now stated unequivocally that unconventional monetary policy has not had the desired effects. The days of negative interest rates could soon be over. His inference is that negative interest rates could be tweaked to become incrementally positive.

Secondly, Rehn notes that the Phillips Curve in the Eurozone is dead. The Eurozone New Normal is thus reality by default implication.

Rehn also makes the massive claim that the ECB’s credible commitment to achieve its inflation target has been lost.

In summation, Rehn calls for a comprehensive review and potential overhaul of the ECB’s monetary policy framework no less. So that was the massive bit. The rump procrastinating bit is that such a process will be so lengthy and cumbersome (unless it has been ongoing by stealth already) that monetary policy will be on hold for some time. The implied guidance that monetary policy easing Shock and Awe is coming, will be a substantial tailwind to growth and inflation expectations in the meantime that the review is under way. If Rehn is the next President, Mario Draghi’s bazooka will look like a pea-shooter.

(Source: Author)

One should not cast aspersions on Mario Draghi for what he has done. After all he did do “whatever it takes”. It’s just that “whatever it takes” now needs more “It” and more time. Draghi has run out of time, but he was never lacking in “It”.

Rehn most certainly is not casting any aspersions on Draghi. Rehn is only saying that the gamble taken by Draghi and supported by him has not played out the way that they both intended. It’s now time for Plan B. Back when this author detected Yield Curve Targeting as the next phase of monetary policy, during a normalization period before further easing, Draghi had already identified the threats that have now materialized. The forces were just bigger and longer in duration than Draghi was able to deal with using the ECB’s current monetary policy framework.

As the changing of the guard at the ECB continues, the Old Guard is now passing the baton to the New Guard.

(Source: Author)

Rehn is simply picking up the baton from a point that Draghi identified some time ago and tried to head off. Rehn will now have to deal with it. He will also have to deal with Banking Union and deeper Economic Union. A policy review and new framework are consistent with these additional objectives. He will also have a new Chief Economist Philip Lane, who already has a solution to these issues in the form of Safe Bonds.

(Source: Author)

It has been suggested in these reports that the ECB has been deliberately abstemious with the new TLTRO, in order to nudge consolidation in the banking sector further along. This incremental provision of liquidity in theory is supposed to get the Eurozone through the ECB’s policy framework review period until Shock and Awe arrives. The central bank is however risking a wider recession in the Eurozone, in order to achieve this strategic objective. The only solution to this risk is for the normalization schedule to be halted, until the wider damage to the Eurozone can be assessed. The working theory is that this wider damage assessment will ultimately require further monetary policy easing.

The game of cat and mouse between Italy and the EU continues. The last report noted Italian attempts at brinkmanship, based on French and wider Eurozone vulnerability to Italian contagion. This brinkmanship was aimed principally at getting the EU to tolerate wider Italian fiscal deficits; and the ECB to buy more Italian debt. More recently, Italian creativity has embraced the idea of becoming a Trojan Horse in the Eurozone for Chinese exports to penetrate through.

The latest Italian push-back is now against would-be consolidators buying Italian banks. The Bank of Italy opines that bail-in rules are weakening Italian banks, thus making them targets. Germany on the other hand, sees the bail-in rules as a key safety mechanism to prevent a repeat of the GFC.

ECB senior supervisor Ignazio Angeloni has been noted as a key man in the process of Eurozone banking consolidation. His MO is to highlight flaws and risks in the banking sector, especially Italy’s, and then to open these cans of worms in order to nudge the consolidation solution forwards. His latest nudge seems to be well choreographed with the vague and controversial new TLTRO III program.

In the latest incendiary commentary, Angeloni opined that the current Italian recession is self-inflicted. This self-harming has been done by the Populists, in their refusal to reform the economy which has then in his view driven up yields and created recessionary headwinds. Evidently, this self-harming does not oblige the ECB to come to the rescue with either more generous TLTRO III and/or more QE though.

Germany has begun its fiscal pump priming, with the objective of stimulating domestic consumption. This will begin with pay increases for its one million civil servants. Pay increases in Germany are averaging 3.5% annually, which are significant in real terms with inflation continuing to flat-line. The Bundesbank is therefore highly unlikely to accept any easing of monetary policy by the ECB.

In the current phony war, presaging a full-blown trade war between America and the EU, Germany just nudged both sides closer to contact. German finance minister Peter Altmaier confirmed that the EU will reciprocate with tariffs, in the event that America moves first with them. A full-blown trade war is now within sight. The trajectory was set some time ago, when President Trump made the removal of tariffs on EU manufactured goods conditional on progress to allow American agriculture access to the European single market.

Thus far, the traditional power of the European farm lobby has maintained the barrier to American farmers. The situation has gotten worse as Populists have set the agenda in Spain and Italy, whilst French farmers have besieged the unpopular President Macron. At the same time, President Trump has tried to garner greater support from the rural hinterland. EU trade commissioner Cecilia Malmstrom recently confirmed that the European farmers have taken her and her team hostage also. There is thus no room for compromise on either side, so a war of tariff attrition must now be prosecuted by both sides.

(Source: History Channel)

President Trump chose to give the current phony war the context of the strategic alliance that underpins it. He would like European hosts (Germany) of Pax Americana to pay cost plus 50%, for the line of American steel that defends their access to the global economy that America also upholds. There is therefore more than just access to domestic American markets on the table. Very simply, if Europe won’t pay then America will fall back on its Pacific imperial mission and leave Europe to the Bear from Russia and the Wolves from Near/Middle-East.

This means that the demise of American free trade with Europe will be joined by the death of NATO. Emmanuel Macron probably fancies Europe’s chances on its own, but older German heads who remember European conflagrations past would disagree. European nations have been paying for populist social agendas more than they have been paying for the collective defense of said agendas. That was when the Eurozone economy was strong. Now that it is weak, there is nothing in the pot for collective defense.

Quite simply, Europe cannot afford to defend itself unless it abandons the fraternal social contract that it is currently pursuing. Such abandonment would play right into the hands of the Populists, who also have their own national military end-games.

(Source: Reuters)

As usual, Eurozone policy makers have their heads in the sand on this strategic survival question. There is a flawed method in their madness however. In an act of ritual nonsense, the EU parliament conspired to vote down resistance to opening trade negotiations with America, only then to vote that this first vote was non-binding. The Eurozone thus has neither policy on improving trade with America nor restricting it with tariffs. They just assume that the Eurozone ship of state, that richly rewards its politicians and central bankers, will carry on regardless of the threat or the cost. Instead of thinking about the big picture, they are focused on the immediate tactical threats in the form of Brexit and Populists on their streets.

As with Britain and the Brexit, America will thus have to take the initiative and force the debate with the Eurozone. The Eurozone will then wriggle and squirm to eke out the current status quo, in the hope that President Trump loses the next presidential election (or gets impeached) and some kind of Obama clone replaces him. What the Eurozone fails to realise is that the global Rubicon of populism and protectionism has been crossed irreversibly. The method in the Eurozone’s madness thus ignores the global reality.

(Source: Bloomberg)

Germany’s military planners are definitely thinking strategically, thereby confirming that a major strategic reset may be coming. They have recently decided to make the annual report on the country’s combat readiness classified for the first time ever. Germany Inc. may also be thinking and talking a little bit too strategically, thereby giving the game away if the words and deeds of the Volksawgen CEO are a guide. The existential threat to its industrial base and its military seems all too familiar. The last report discussed Mario Draghi’s vision of integrated Eurozone strength through joy of governance by un-elected policymakers. The unnerving historical parallels keep on coming as the Eurozone economy keeps on sliding. What is most unnerving is their articulation by key individuals, who are orthodox mainstream practitioners, rather than populists at the extreme end of the political spectrum.

The latest meeting of Eurozone finance ministers contrasted sharply with the contemporaneous Brexit compromise deal being offered to Britain. The Eurozone ministers all fell into line behind a common Eurozone budget that will offer fiscal assistance to nations who take structural economic reform initiatives. Totally missing, from the parochial discussions, was any discussion of a common defence budget in the event that trade with America deteriorates and NATO collapses.

The meeting also showed that the Eurozone nations currently only have just less than half of the 55 Million Euro initial common budget that they envisage. There was a clear lack of takers for the process of topping up this structural common budget deficit. In the past, clever Eurozone negotiators have expropriated funds, via the EU budget gateway from Britain, that have then found their way into the exclusive Eurozone (therefore non-inclusive of Britain) currency budget pot. The EU is still trying to get Britain to pay its dues to the Eurozone through the negotiated Brexit.

A Hard Brexit, in which Britain pays nothing, would effectively make raising the common Eurozone budget impossible to achieve. Britain’s big negotiating card, which its negotiators are blissfully unaware of, is its impact upon the common Eurozone budget. Free movement of people and the Irish border are great stories, but they lack the kind of financial impact that closes deals conclusively. Both sides of the Brexit negotiating table are thus negotiating, to try and sustain a delayed Brexit status quo, before President Trump removes the negotiating ground under their feet.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.