Tag Archives: ECB

The Signal and the Noise (Part 5)

So how do you decide?

Photo: Sebastian Lühnsdorf. Source: Morguefile

When a news event occurs, is it a new signal, or is it just noise? The European Central Bank is maintaining a negative inter-bank rate – is it signal or noise? The Consumer Price Index just came out flat from the month before – was that signal or noise?

It’s tempting to label all these interim economic reports financial static. And a lot of them are. So much data comes at us from so many directions that it’s hard to decide what we should care about. Consider inflation: two government agencies report three different indices, each of which has dozens of sub-groups. Or employment: it’s measured two different ways, and each indicator has both leading and lagging elements. If you look too closely, you get spots in front of your eyes!

If you’re involved in the markets, your attention should be determined by your perspective. If you have a long time-horizon – saving for retirement while in your ‘20s or ‘30s, or establishing a young child’s college fund – you should perhaps keep an eye on broad trends, but that’s all. Regular saving through all the ups and downs will probably be your best approach.

Similarly, if you’re drawing regularly from your nest-egg and most of your assets are committed to short-term bonds, the market’s squiggles and jiggles also shouldn’t affect you much. But when you’re in the middle – still saving, but getting closer to needing the funds – then the news will have more impact. A change in the economy’s direction might call for a change in your tactical allocation. Still, even then, looking at the trends and averages makes more sense than trying to follow every tick and tock.

In the end, whether a report is signal or noise depends on your perspective. One investor’s warning sign is another’s annoying distraction. But even the Federal Reserve – our most economically sensitive agency – only reviews policy every other month. That’s more than enough for most investors.

Douglas R. Tengdin, CFA

Draghi’d Forward

Exceeds expectations.

Photo: Frankfurt Skyline; Source: Wiki Commons/Thomas Wolf

That’s what I thought when I read about the European Central Bank’s program to expand the Eurozone’s money supply by buying government bonds, commonly known as quantitative easing (QE). A week ago, rumors were circulating that they would buy about €700 billion worth of bonds. But yesterday Mario Draghi announced that the program would be more than €1.1 trillion. Markets around the world rallied on the news.

Continue reading Draghi’d Forward

(Currency) Wars and Peace

What’s happening in Switzerland?

Source: Wikipedia

Yesterday the Swiss National Bank announced they would no longer keep the Franc pegged to the Euro. The currency immediately jumped about 20%, roiling the markets. Some currency trading firms have been wiped out. They also lowered the deposit rates for banks to -0.75% to discourage inflows. Why did they do this?

Continue reading (Currency) Wars and Peace

Carry On, Mister Trader

Why are bond yields so low?

Source: Daily Telegraph

One of the most surprising market moves of 2014 was the persistent rally in US Treasury Bonds. It wasn’t supposed to be this way. Starting in April of 2013, rates were supposed to normalize. That’s when Ben Bernanke signaled that the Fed would gradually end its bond-buying program known as Quantitative Easing. Continue reading Carry On, Mister Trader

Going Negative

So much for the zero-bound.

On Thursday the European Central Bank lowered the interest rate it pays banks on their reserve balances to negative 0.1%. Now it will charge banks money for keeping balances with the ECB. Economists used to discuss negative rates the same way engineers talked about flying cars: possible in theory, but just not practical and never seen in reality. But several advanced labs are working on practical flying cars, and the world’s second largest central bank has now gone to negative rates. What’s next, warp drive?

Before we talk about what the measure will do, let’s talk about what it won’t do. It won’t immediately spur lending, as many commentator suggest. That’s because reserve banking is, in the short run, a zero-sum game. When a bank makes a loan, the money doesn’t disappear. It just gets transferred from one bank to another. The banks may play “hot potato” with the money, but some bank somewhere is stuck with the balance and has to pay.

What it will do is cut interest rates on short-term government bonds, like it did in Denmark two years ago when they went negative. That had the effect of pushing yields on Danish T-bills into minus-land. Eventually, Euro-land banks may put their money into riskier assets, but they also face stress-tests and other anti-risk pressures from their regulators.

In real terms, short-term rates have been negative a long time, with inflation higher than bank rates. Now, with the ECB paying negative nominal rates, rates are low enough to make our heads hurt.

Douglas R. Tengdin, CFA

Chief Investment Officer

In Praise of Flexibility

Everyone wants rules. But sometimes they lead you astray.

In mid-2008 everyone was watching oil and the end of the housing bubble. Oil had recently broken $100 per barrel and many expected that it would soon double in price, adding to inflation. Bear Stearns had just gone bust. Bank managers weren’t sure where their funding would come from each night. Everyone expected further fallout.

In the midst of this, the European Central Bank raised rates. Their inflation indicators—impacted by oil prices—where flashing red. By their rules, they had to raise rates to fight inflation, no matter what the rest of the economy was doing.

The ECB’s rate hike in July of 2008 will likely go down in history as one of the worst Central Bank mistakes ever: tightening in the teeth of a huge financial crisis. After the failures of Fannie and Freddie, AIG, and Lehman, they reversed course and cut rates—following the Fed and the rest of the world.

This is relevant because the Fed is now reexamining its rules for monetary policy. Janet Yellen is a big believer in transparency; rules-based monetary policy might be the next step. But the ECB’s rate-hike in 2008 is cautionary: some rules are made to be broken.

Douglas R. Tengdin, CFA

Chief Investment Officer

Going Negative?

Is Europe headed for negative interest rates?

The Euro-zone has been in recession since mid-2011. Their recovery from the Financial Crisis of ’08 and ’09 was tepid, and the currency crisis over there has severely damaged business and consumer confidence.

So ECB President Draghi is considering setting negative interest rates on bank reserves—charging banks for the privilege of stashing cash with the central repository. There’s precedent for such an action: Switzerland and Sweden have had such a policy in the past, and Denmark cut its deposit rate below zero in July of last year.

Negative rates are usually the response of a small economy to large capital in-flows—they discourage speculation. But they’ve never been used as a policy by in a major economic power. Nevertheless, when these smaller countries implemented them, they didn’t lead to major catastrophes. After all, we’ve had negative real interest rates over here for years. Negative nominal rates would be an annoyance, not an apocalypse.

But negative rates would be a distraction from Europe’s real problem—a disharmonious banking system and an anti-competitive labor market. Until they address those issues, Europe’s economy will hobbled.

Douglas R. Tengdin, CFA

Chief Investment Officer