Monday, March 14, 2016

ECB Rate Meeting

Quite a bit of talk about our good friends in Europe lately, but they are an important piece of the global economy we participate in. I had some time to think about all the measurements taken and here are my thoughts.

The ECB did a few things that surprised people. For one it decided to increase the size of its bond buying program. This is similar to what the Fed did when it expanded it's QE program.  When you have to increase the size of a program meant to provide stimulus it's probably because you aren't seeing the effects you thought you would. Not a good thing. Additionally the bonds allowed to be purchased were expanded to non-bank institutions and Euro Zone companies. In other words what will happen is banks holding the bonds of Siemens or BASF can now cash in those bonds to the ECB for a direct liquidity injection. But I'm inclined the banks will not sell their highly rated debt, but instead sell other riskier bonds from weaker companies that qualify under the new program. 

Also the deposit rate was cut to -0.4%. As if you didn't get the memo the last time around the ECB will be taking 0.4% of your money for depositing it there instead of 0.3%. If you live in Europe and your bank is doing this you should switch immediately for it shows their incompetence. This is supposed to force banks to lend the money. Well here is the catch. Banks will do one of three things. 

1. Send the money overseas to foreign operations or central banks if possible for their institution. 
2. Store the money in their own vaults. 
3. Put the money into other alternatives such as short term corporate paper or equities. 

Also just because people are being enticed with low rates does not mean they will borrow. Even if I could get a loan at 2% for 10 years I still might not do it if I can not reasonably expect to make more than that by deploying those funds. EU GDP growth is coming in around 0.5-1.5% so I'd be duly unmotivated to think I could make 5 or 6% given the burdensome amount of regulations and taxes. It's just not worth the effort to plenty of people. 

Lastly the bond buying program was extended to go until March 2017, the marginal rate was cut to .25%, and the bank pledge to keep rates low for an extended time. Sounds a lot like the Fed a couple years ago. I think most people would agree none of our countries problems were fixed from that policy. It's why Trump and Sanders are causing such problems for the establishment. People know something is wrong and its likely their pocketbooks first and foremost. Often overlooked is how this affects pension funds. Most funds buy large portions of government debt. With yields so low its hard to imagine how on earth they will live up to their 7-8% return projections. This is going to squeeze the funds hard as they must continue to make distributions while reinvesting at lower rates of returns. The same issue is going to materialize in the US eventually. We just have been lucky so far to have somewhat higher rates, and a stock market that has performed reasonably well the last 5 years. 

Altogether it seems like the ECB is caught between a rock and hard place. If they were setup like the Fed I'm sure they would have embarked on this plan awhile ago. Time will tell if it's all to little to late. The turning tide could be so great it wouldn't even make a difference if the program was twice as big. We shall see what the future holds. 

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