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Weekly Update 8 December 2014

As, this year, the ECB has proved to be the driving force behind the fixed income and credit markets, Mario Draghi’s comments, on 4 December 2014, marked the end of the year and heralded expectation for 2015, all in a relatively flat calm. He could not easily have announced some kind of change to close the year ... whether positive or negative, so he remained very cautious about what is to come. Obviously, he prefers to take his time to think, weighing up the effects of the unconventional measures taken, unprecedented, in Europe, rather than making hollow promises and disappointing the markets, which would lead to a major crisis of confidence. Luckily, central bankers are much more prudent than the politicians.

So, the ECB would appear to have announced that it is essentially in a phase of assessment and preparation, from which we conclude:

  • Buy securitisations ... if, of course, they exist, which in fact they don’t ... yet!
  • Buy corporate bonds: maybe. Difficult to know which ones, then, how many and in what proportion. Most companies are borrowing at historically low interest rates and do not need to see the rates fall any lower; they just need growth projects to finance and they haven’t got any. Some companies are taking advantage of these low rates to issue large amounts of perpetual securities, thereby building up capital at low costs (50% on a hybrid). We can only hope that the ECB will not buy such bonds as collateral for money creation as they are callable if all goes well but perpetual, if all goes wrong.
  • Buy sovereign bonds: this is the most immediate and logical route, but raises a number of regulatory, technical and economic questions ... not usually a good mix. … If it is to respect economic theory, the ECB should buy bonds from countries which have the highest ‘interest rate/ROC’ ratio, i.e. bonds from peripherals, such as Greece or Portugal but core countries such as Germany and France, do not accept this because they clearly need stimulus to get restarted (or start at all!)

All of this in the name of the struggle against deflation, which, nonetheless, appears to be knocking on the door. We note that Mr Draghi referred to the downwards revision of growth and inflation, which were not expected to be very high in the first place. The ECB has revised expectations for 2015 from 1.1% to 0.7%, which is no anodyne revision. Furthermore, this revision does not take into account the recent drop in oil prices from $80 to $65, which will also have an impact and lead to even lower inflation in 2015.

So we can expect deflation, unless, as the most optimistic would argue, the euro starts to play in favour of Europe’s exports. We note, however, that the ripple down effect is not at all as fast so that the impact on competitiveness of a depreciated euro will filter through in 2016, at the earliest… In the meantime, we will have to content ourselves with low interest rates, mild inflation, a dim outlook, very sluggish growth and ... the risk that the downwards spiral into deflation will be triggered.

The only ones to benefit (and we can imagine without any problem their speeches putting up a smokescreen over fears of deflation) are the major, debt-burdened countries in Europe – here, France and Italy spring to mind - which  almost for free, can press on with mismanagement, as they have for the last 30 years or so. They do not need development projects, rosy outlooks, economic evidence, the release or sound and reliable results in order to rack up debt. They need only three elements, which they have the good fortune of having and being able to manipulate at will:   
- The Central Bank : albeit independent, it is more or less at the service of the member governments.

- Regulations: insurers and bankers will tell you what proportion of government bonds they must now include in their portfolios in order to comply with the rules.

- Size: when we are Europe in the world or France in Europe we are ‘systemic’ and can do almost anything, as France’s Prime Minister told the Germans recently, ‘we are all in the same boat’ so that  ‘if we go down, you go down too’.

So, we wonder whether the ECB is as bothered as we are by low interest rates and asymmetry on the market: technically, resolving the banking crisis (which triggered the 2008 financial crisis) was complicated, albeit easy. All that had to be done was for financial authorities to impose government-defined rules (currently in the course of implementation) and we are already seeing the effects. It is more complicated to resolve the sovereign crisis which emerged in 2011. And we can’t yet see the outcome. Apart from Greece and Portugal, which were not lucky enough to be systemic, or Spain, which for a long time adopted a US-type resolution model (severe cuts and immediate recovery), the others, particularly, don’t seem to care a toss about their debt burdens: the instant lending rate is free and deflation will serve to reduce the principal. Some empty speeches about recovery will – or not – help those concerned swallow the pill.



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