In Latest European "Stress Test" Farce, ECB Assumes No Deflation Even Under Severe Systemic Shock

Tyler Durden's picture

In what is now an annual attempt by regional central banks to shore up confidence in their insolvent banking systems (because if they were solvent, there would be no need for such optical gimmicks as "stress tests"), yet which end up nothing shy of an all out, humorous farce, earlier today the EBA published its methodology for the 2014 EU-wide bank stress test. Before we go into the details, a quick refresher on why instead of boosting confidence in banks, these periodic wastes of taxpayer funds achieve anything but. After all, who can forget that back in 2011 it was none other than Dexia that was supposedly the best performing bank in Europe.

Of course, Dexia was promptly nationalized shortly thereafter after it was Lehmaned.

But it is not just Europe: America's own Fed cleared the 2014 US stress test-participating banks to issue more capital to shareholders just one month before Bank of America revealed that it had botched its calculation of its regulatory capital, and as a result was scrapping its capital return plan.

Some supervision; some confidence building...

But back to Europe where as noted above, earlier today the EBA published its common methodology and scenario for the 2014 EUwide bank stress test. The adverse scenario covers the period 2014 to 2016 and at least on the surface is generally tougher than the adverse scenarios in previous similar exercises, resulting in a severe negative deviation of EU GDP growth of 7% from its baseline level by 2016.

So far so good. But where the whole thing disintegrates into yet another sham spectacle confirming just how insolvent European banking truly is, is one simple observation: not even under the adverse scenario does the ECB contemplate the possibility of deflation!

That's right - so atavistic is Europe's fear of deflation, that even in what is supposed to be a purely hypothetical scenario which by definition should cover all unpleasant possible outcomes, did it not cross the mind of the test arranger to speculate that Europe, which already is struggling with deflation and will fudge each and every inflation print to make inflation appear higher than it really is, could enter outright deflation.

Needless to say, the glaring omission of this most probable path for European asset prices, makes the latest Stress Test immediately null and void. What is worse, the fact that the ECB made it a point of excluding this possibility, shows just how terrified Europe is of declining prices (for which Draghi can thank his colleague Kuroda who has been engaging in a historic episode of deflation export for the past year), and that should deflation indeed flare up in Europe even more, then all bets are off.

Here is SocGen's take:

On inflation the adverse scenario lowers inflation by 1.3pp in 2016 compared with the baseline, resulting in still positive inflation of 0.3% in the euro area. Noteworthy is that among the larger euro area countries, France would be the only country to enter deflation in 2016, while both Italy and Spain would have higher inflation than Germany. While these scenarios are static, assuming no change in commodity prices and monetary policy, they suggest that it would require a rather big shock in the euro area to see a clear deflationary scenario developing for the area as a whole. This is somewhat surprising given the recent vivid debate on whether the euro area is already close to deflation or not.

As we said, superficially at least, the stress test is said to be tougher than any previous one. What "tougher" means however in the context of a world where banks (as Bank of America did) can and will openly fudge and make up whatever numbers they wish, is debatable. Here are the details:

Stress tests tougher than in the past, but banks may also be better prepared Compared with previous stress tests, the new adverse scenario is both more demanding and long-lasting (3 years). As regards, GDP growth, the negative deviation now stretches over three years, implying a decline of 7% for the EU, compared with a deviation of around -2% per year in the last Stress Test. Also the decline in house and stock prices in now more pronounced while the rise in bond yields is significantly higher. The rise in short-term interbank interest rates is however more muted this time, while the change in the labour market is broadly similar. While this all suggests a tougher test for banks, banks are likely also in a better position in terms of capital and earnings than they were in the past which should mitigate the impact.



On top of the common shock to short-term interbank rates, the ESRB also includes a more generic shock to EU banks’ funding access, capturing both cyclical and structural forces. Interestingly, the cyclical factors are said to be “rooted in concerns about insufficient balance sheet repair due to doubts about the public backstops available for the Comprehensive Assessment”, which is in line with the ECB’s previous criticism on the progress with Banking Union. This shows an encouraging willingness by the ESRB to acknowledge that the slow progress with Banking Union can have tangible costs.

Here we will reserve our right to laugh: after all it was the IMF itself which said in August of 2013 that the "Eurozone Funding Shortfall Rises To Over $4 Trillion, Increases By More Than $500 Billion In A Year." In other words, all Europe can hope is to kick the can indefinitely and pray nobody asks to look under the cover of what is really happening, and certainly not force the ECB to use its magical, and still completely non-existent OMT program.

But what is the straw that breaks the camel's back is the following blurb:

No deflation expected in the euro area even in the adverse scenario (!)

This scenario analysis naturally represents a relatively static view, providing a snapshot of shocks and bank’s balance sheets at a particular point in time (Q42013). For instance, no changes are assumed on oil, non-oil commodity prices or monetary policy. Interestingly, even if the magnitude of the shocks is larger in this exercise, the effect on inflation appears to be more muted and delayed. With a larger drop in GDP growth than in 2011, inflation is still only expected to decline by 0.1 and 0.6pp compared with baseline in the first two years, whereas in 2011, the decline was 0.5 and 1.1pp in the first two years. This may relate to the fact that inflation now is much lower, and possibly stickier, but it also suggests a surprising resilience to a negative growth and financial market scenario. Interestingly, only France (along with five other euro area countries) is expected to see negative inflation in 2016, whereas both Italy and Spain would have higher inflation than Germany. A relatively large shock would thus be necessary to tip the euro area into deflation, possibly larger than what is currently commonly assumed given the already vivid debate on whether the euro area is already close to entering a deflationary scenario.


This points to the difficulties in designing realistic scenarios (without affecting expectations), with success only possible to establish ex post. Still, progress has been made from previous Stress Test exercises in terms of stringency, length and transparency of the adverse scenario, which should ultimately benefit the robustness of the upcoming Stress Test.

Yes, progress, from one fabricated and completely worthless "test" to another, neither of why has any utility whatsoever. But at least someone, somewhere is expected to feel more "confident" about European banks (of which Deutsche Bank as we observed yesterday, has a total notional derivative position of $75 trillion, or 20 times more than the GDP of Germany).

And since our running commentary on this particular farce from the central bank toolkit has been well-known since our running commentary on the first 2010 European stress test, we will leave it to SocGen instead:

One could question the pass-through into  inflation or whether the (ECB’s) baseline inflation outlook in fact constitutes a relatively optimistic scenario.

Translation: even SocGen, with its own share of balance sheet issues and happy recipient of ECB generosity for years, thinks the latest and greatest stress test is a joke. In that case what is everyone else supposed to think?

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Groundhog Day's picture

As long as you keep your head in the sand....all will be well

Timmay's picture

Good Italian friend of mine once told me, "A man is worth whatever he can get his hands on in 24 hours."


That seems like a good rule of thumb to apply to everyone and everything in determining the value of something.

Say What Again's picture

This mind set musty be behind the VXX slam, with all the VOL indexes heading down to 0.  Since nothing can ever go wrong, VOL belongs at zero.

Xibalba's picture

These guys are paid to make this shit up.  Just think about that for a second.  

Say What Again's picture

I know what you're talking about.  Just like the way Abe, and his buddies in Japan releases a "News" about how they will be doing moar QE at 1:00 A.M. Tokyo time.

Manthong's picture

Won’t they be surprised as the next hiccup makes their economies contract faster than a whoopee cushion being sat upon by Michael Moore.

Drifter's picture

Even in a collapsing economy they can keep bond values up using the oldest trick in the book, currency printing and resulting inflation.

Zimbabwe's stock market soared while the economy collapsed. How? Massive currency printing and hyperinflation.

It works because nominal values are all that matter. The numbers on the tickers, quote screens, etc. Long as those numbers keep rising everybody is happy.

Any central bank in any country can guarantee no deflation. All they have to do is crank the printing press up faster, print lots more currency.

Doesn't matter what the economy does. They don't care about the economy anyway.

ArkansasAngie's picture

Of course they didn't assume deflation.  Then all the banks FAIL.


Mercury's picture

ECB Assumes No Deflation Even Under Severe Systemic Shock


I hear the helicopters coming


CrashisOptimistic's picture

I suspect the ECB also assumes no restriction of natural gas or oil supply from Russia.  That couldn't happen, you see.

Seer's picture

We're talking the paper world here, please move along! </sarc>

Bryan's picture

Is that "D" word even in the bankers' dictionary?

sessinpo's picture

Bryan      Is that "D" word even in the bankers' dictionary?


Why would it be? With all the massive printing by the FRB, ECB, and BOJ, everyone for years have feared and talked about inflation or hyperinflation. Most of them have been PM bugs.

But as I have said for years, deflation is the problem because of debt. Basically debt absorbed money printing, thus that money isn't circulating throughout the economies. Yes, we have had some price inflation in come areas, but based upon the massive amount of printing, those price increases are tame. Consumers feel the pinch because everyone is fighting for scarce dollars. If we had no debt, at the current levels of printing, we would see $10 plus for a loaf of bread, but we don't.

Yen Cross's picture

   Look at the size of todays REPO... Unfucking believable!     [ $183.327 billion]   That's no typo my friends.

Grande Tetons's picture

Junkies always need more smack to achieve the same high. 

YC, I checked the site and it looks like they did 242 at the end of last month. Then a descent in early April.....with a hockey stick to the end of this month.  Taper shmaper. 


Yen Cross's picture

  The Fed has no intention of ever drawing down liquidity. They've just tried to create the illusion for the sheeples. Between backdooring treasury purchases through Belgium and Reverse REPOs the fed. has just become even more sneaky and controlling.

Grande Tetons's picture

I checked. Based on my anecdotal evidence...the sheep have never heard of the taper. So, really, who are they trying to kid?  Maybe, they just are addicted to lying and bullshit and can not stop. Yeah...I am going to go with that. 

RealityCheque's picture

hold the fucking phone: 183 billion?? Is that really correct?

Not doubting you at all, I just looked at the number. I'm only questioning it because it seems utterly mind boggling.

teslaberry's picture

at least they are being honest about their future intentions. print till the moon.

there will be no 'deflation' of the money supply. they will print more money.

how the settlements of debts , and prices respond makes no difference. because there will be a crash of the availability of supplies and high quality services. but don't worry----cheap and free labor will be plentiful.

Fuh Querada's picture

"Draghi is the model Central Banker"
James G Ricktards during a BBC interview

Soul Glow's picture

Yeah, because he is a duchebag.

Fuh Querada's picture

Both in effect. Ricktards is a double agent. He is a jockeying for a high position in the NWO. Draghi is just a Goddam Sucks Stooge like Carney.,

Joebloinvestor's picture

It is just a bunch of BULL SHIT that tries to keep money from taking flight.

maskone909's picture

The fact that they have to do these "stress tests" speaks volumes to the solvency of these institutions.

Where there is smoke there is fire.

trader1's picture

you're all missing the biggest story in the world right now.

For the first time ever, you get to watch live EU Presidential Debates, where an EU citizen can make their choice from a pool of candidates representing the entire political spectrum (the left, socialist, green, democratic/market liberalists, conservative/centre-right), rather than the silly demopublican, limited-choice, fixed, bs...

Seer's picture

Psst!  It's the SYSTEM!

john39's picture

this wouldn't be allowed if the outcome were not fixed  (all candidates are controlled, one way or another).  voting in the system only validates the system.

trader1's picture

actually, this system is pretty cool.  much better than US.  just think of the dynamics of the usa, if you guys were to adopt the following voting procedure:

7. Taking into account the elections to the European Parliament and after having held the appropriate consultations, the European Council, acting by a qualified majority, shall propose to the European Parliament a candidate for President of the Commission. This candidate shall be elected by the European Parliament by a majority of its component members. If he does not obtain the required majority, the European Council, acting by a qualified majority, shall within one month propose a new candidate who shall be elected by the European Parliament following the same procedure.

The Council, by common accord with the President-elect, shall adopt the list of the other persons whom it proposes for appointment as members of the Commission. They shall be selected, on the basis of the suggestions made by Member States, in accordance with the criteria set out in paragraph 3, second subparagraph, and paragraph 5, second subparagraph.

The President, the High Representative of the Union for Foreign Affairs and Security Policy and the other members of the Commission shall be subject as a body to a vote of consent by the European Parliament. On the basis of this consent the Commission shall be appointed by the European Council, acting by a qualified majority.




Martin Schulz, the candidate for the Socialists and Democrats, told the Süddeutsche that Mr Van Rompuy’s declarations were the expression of his "own opinion, based on his interpretation, to fit his job description. Many in the European Council see this issue [of a common candidate] differently. Most importantly, the European voters see this differently.”

“We were disappointed to hear this message from Mr Van Rompuy," said Julian Priestley, the former secretary general of the European Parliament who leads Schulz’ campaign. "It seems he continues to deny the will of Europe’s voters and dismiss the democratic legitimacy of the upcoming elections,” Priestley told EurActiv.

The five candidates for the job also include the Belgian liberal Guy Verhofstadt, the Greens’ Franco-German duo José Bové and Ska Keller, and the far-left Greek candidate Alexis Tsipras. All are currently touring EU member states, supporting national parties in their bid to get voters to the polls on 22-25 May.

“Mr Schulz and I are touring the whole of Europe, to make clear the stakes of the elections," Juncker stressed, saying "Every citizen can co-decide the direction of Europe for the next five years."

European parties have an informal agreement that the party winning the most seats can put forward its candidate for the EU Executive.

Latest polls put the EPP in the lead with 222 projected seats, followed by the socialists with 209 seats. The liberal ALDE party is credited with around 60 seats, the far-left GUE-NGL around 50 seats and the Greens and Conservatives with about 40 seats each.

Crunch time

Between 22 and 25 May, European citizens will elect a new European Parliament, made up of 751 members. For the EU executive however the 27th May will be the decisive date, with EU heads of states meeting in Brussels to designate the new Commission President.

In Parliament, the designated Commission chief will need the backing of at least 376 MEPs in order to get "elected". Most likely, a grand coalition will support the winning candidate - whether Martin Schulz, Jean-Claude Juncker or someone else. A coalition of socialists, liberals, greens and the far-left could provide Schulz with a majority but polling shows that this is highly unlikely.

However, political parties have always kept the door open for coalitions to support a candidate. “We will then work to build the coalition which will have the necessary majority to elect Martin Schulz and to put the EU on a new path, strengthened by this new democratic underpinning,” Priestley said.

Ultimately, all will depend on the endorsements of the European Parliament and the 28 EU heads of states. So what will happen on 27 May?

  • Morning: The European Parliament’s conference of presidents meets in Brussels, in an extraordinary session. The meeting will include lead candidates Martin Schulz and Guy Verhofstadt, as well as political heavyweights like Joseph Daul (EPP) and Rebecca Harms (Greens).
  • Afternoon: Traditionally, the pan-European parties meet up in pre-election summits of their own member parties. These pre-election summits are attended by heads of state – a crucial moment for the parties’ leadership and the candidates’ entourage to get an endorsement on a potential deal in Parliament.
  • Evening: The European heads of state are gathered by the European Council president, Herman Van Rompuy, for an “informal dinner” to discuss the elections. Key question: will the EU leaders stand by the process of ‘Spitzenkandidaten’ or not?

If all goes according to plan, political parties will first have to come to an agreement and gather the necessary votes in Parliament. Then, the heads of states will give their blessing to the candidate.

But 'dark-horse candidates' could also emerge at the last minute if none of the leading ones find the assent of EU leaders. These might include the managing director of the IMF, Christine Lagarde (centre-right) or the former president of the World Trade Organisation, Pascal Lamy (Socialist).

Those defending the single candidate procedure do not want to believe in such a scenario. “Already 27 out of the 28 Heads of Government have endorsed this system,” Priestley said. “It would be a travesty if they went back on their commitments in June.”

In case a 'dark horse' candidate emerges, it could bring the institutions into a deadlock and put Van Rompuy head-to-head once more with the pan-European parties.

MillionDollarBoner_'s picture suck ass!

Why don't you just shut up?!?

trader1's picture

not until you offer something more than 2 lines of teenage angst...

your other posts aren't that bad...

so, why don't you try again to be funny, but also inject some philosophical references into a retort?

Seer's picture

I think that this also says: "You will buy what we tell you to buy!"  as long as we're using Their currencies then they are going to tell/force us what to buy.  If we don't buy what the're pushing then deflation is pretty much the "default."

Save_America1st's picture

The Farce is strong in these swindlers...may the Farce be with them...

Seer's picture

Prediction: FAIL- they'll end up doing a farce plant!

Soul Glow's picture

This is what most people don't understand - paper over a lie all they want, the end result is still the lie.

Seer's picture

Mother Nature doesn't like being lied to...

Soul Glow's picture

It's Tuesday!  Sell the fucking top!

Yen Cross's picture

 I tried shorting aud/jpy and it pissed in my face for 15 lousy pips. Although I do think this EOM risk-on farce is going to wind down into the Fed. and BoJ.

Seer's picture

Meanwhile, in the US, all is fine:


U.S. consumer confidence near six-year high, home prices rise

But wait!

Detroit Homeowners Gun Down Burglars as Police Wait for Cars

All under control, all under control...

Seer's picture
Bank capital is an illusion: Bethany McLean

Not sure about her claim that things are better, but all else, logic-wise, seems pretty spot-on.

sessinpo's picture

Seer         Not sure about her claim that things are better, but all else, logic-wise, seems pretty spot-on.


Such as " McLean calls herself a perma-bear, and says she’s worried about a tech bubble, profit coming from cost-cutting and not growth, and the slow-down in China."

Like most analysts, she puts in that caveat to cover their ass. I am bullish and I'm bearish, so I'm right either way.

jmcadg's picture

So this must mean ... BTFD, BTFATH, BTFWWIII, BTFSCCWMB (Buy the fuckin' shit, cock, cunt, wank mutherfuckin' bullshit), at least between 2014 and 2016!

Watson's picture

...and still completely non-existent OMT program...

Whether or not there is an OMT depends on what Germany wants - Draghi himself has no power.

Since Merkel won her election, and she really believes in the United States of Europe, if she thinks OMT is necessary German taxpayers will be the buyers.

That does not mean that OMT, even if implemented in the size and scale possible with a Merkel blessing, will actually achieve anything...see Japan.

Ghordius's picture

"That's right - so atavistic is Europe's fear of deflation, that even in what is supposed to be a purely hypothetical scenario which by definition should cover all unpleasant possible outcomes, did it not cross the mind of the test arranger to speculate that Europe, which already is struggling with deflation and will fudge each and every inflation print to make inflation appear higher than it really is, could enter outright deflation."

don't agree. Europeans worried about deflation? wrong continent

observer007's picture

US confirms its first case of MERS virus