The Chart That Crushes All Credibility Of The ECB's Latest Stress Test

Tyler Durden's picture

While we would be the last to comment on the ECB's laughable forecasting capabilities, we do have to note that there is a bit of a disconnect between the ECB's projections of Eurozone inflation for 2014, 2015 and 2016 as presented in its March, June and September meetings...


... and what the market is currently anticipating based on 5Y5Y forwards which as we noted two weeks ago, recently hit an all time low.


The reason we bring this up, is because just after the latest "most serious, most confidence inspiring" stress test was revealed, that perpetual troublemaker, the head of Germany's IFO Institute, Hans-Werner Sinn, who relentlessly refuses to drink the European Kool Aid, pointed out something rather stunning. According to Bloomberg, in an emailed statement, Sinn said that "ECB avoided modelling a deflation scenario for southern Europe which explains why the capital shortfall was so small for many banks."

Additionally Sinn said that the change in relative prices that includes inflation in north and deflation in south is “unavoidable” if southern European countries are to regain competitiveness without euro-zone inflation. He added that regaining that competitiveness solely via inflation in north - something Germany clearly is not too crazy about - would violate ECB mandate. HIs conclusion: the AQR/stress test implied inflation for all of euro zone to prevent too many banks from failing test.

We will leave what the ECB implied aside for the time being, and instead merely focus on his claim: if indeed the ECB completely ignored to model deflation as a possible outcome, then it makes an even greater mockery of the ECB's pet "confidence building exercise" within the financial community.

And sure enough, within the massive 178-page Stress Test document, there is a "whopping" 4 mentions of the word inflation (deflation appears just once).

Here is what the "Stress Test" does say about inflation:

... while the adverse scenario does not strictly embody a prolonged deflationary environment [ZH: because it clearly does not embody any deflationary environment], it does entail material downward pressures on inflation. Thus, the scenario leads to annual inflation rates for the euro area below the baseline rates by 0.1 percentage points in 2014, by 0.6 percentage points in 2015, and by 1.3 percentage points in 2016. The implied adverse inflation rates amount to 1.0% in 2014, 0.6% in 2015 and 0.3% in 2016.

Which brings us to the chart that renders the ECB's entire exercise in goalseeked stress meaningless and with zero credibility: presenting the ECB's "worst-case" inflation assumptions.

What is the common with the forecast inflation bars shown above? They are all positive, meaning wven in the worst case scenario, the ECB does not think deflation is even a possibility! (and whatever you do, don't look at the 2014 "worst-case" inflation forecast and compare it to the ECB's revised September forecast).

So just as the Troika "never modeled" a Grexit from the Eurozone, and just as the ECB "never modeled" for the Euro to be replaced by its predecessor sovereign currencies - who can forget Mario Draghi's famous "There is No Plan B" speech... which turned out to be glaring lie - simply because the mere assumption of such an outcome would lead to its reality in a self-fulfilling prophercy, so the ECB, in its allegedly most stringent stress test yet... "never modeled" the one most likely outcome for the Eurozone: deflation!

Ironically, for once journalists did not give the ECB a hall pass, and at the press conference for the Stress Test results, there was this exchange with the ECB's Constancio:

My question would be on how credible these tests are. Looking at the adverse scenario, you haven't even included deflation. You have not included an interruption in gas imports to Europe. You have not included full-on sanctions on Russia. So please elaborate and convince us.


Constâncio: The scenario for the stress test was published earlier in the year, so some of the things you mentioned would not have been considered. But indeed, what was considered is a severe shock being the growth of other countries. If you look to the scenario, you see that for the US, there is also a big deceleration of growth which is part of the scenario and also for other countries that are the markets of the euro area. So that is embedded in those assumptions of indeed a big drop in external demand directed to the euro area. That's the first point.


The scenario of deflation is not there because indeed we don't consider that deflation is going to happen.

So.... wait a minute.

Just because the ECB, in all of its brilliance - brilliance which apparently was not brilliant enough to realize that there is, first, not nearly enough ABS in the private market for the ECB to monetize, to bring its balance sheet up by €1 trillion and, second, as its Reuters trial balloon revealed, an ECB monetization of corporate bonds would amount to... a negligible €10 billion per month - does not think a scenario is possible is precisely the necessary and sufficient reason to not include it in the stress test.

Uhmm, guys in Frankfurt: here's a tip - the quote-unquote Stress Test, and especially its adverse scenario, is precisely there to "assume" everything that you don't consider is going to happen! Because otherwise, there is no need for a stress test: one can just wait every quarter and watch as the ECB's forecast grinds lower and lower until deflation becomes the norm. A norm which the ECB "didn't consider is going to happen."

Because how do you rebuild confidence in a system in which the market is telling you deflation is the most likely outcome, and yet you fail to even model for it because, drumroll, you want to rebuild credibility, however by only modeling what you, and not the market, "consider will happen"!?

Oh, and the final reason why one can stick a fork in the ECB's latest attempt to "rebuild confidence", is that when preparing to report its stress test results, the ECB would at least look at what Eurostat revealed on October 16 regarding European inflation. Or rather deflation. For those who missed it, such as the entire ECB governing council apparently, 8 countries in Europe are already in outright deflation, including, but not limited to the bulk of the PIIGS, namely Spain, Italy, and Greece.

That said, despite the complete humiliation that was the ECB's latest stress test, we commend the ECB for working on a Sunday in releasing the stress test and actually holding a press conference on a day when the entire deflationary continent is relaxing in the park, drinking an espresso and smoking a cigarette.

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ekm1's picture

Hans Werner Sinn the real expert who actually showed how ECB does monetary policy by looking at Target2 unpaid bills.

The guy is superbrilliant. 

Reading Sinn is where I learned how Euro, ECB and Target2 are all one system.


This is crystal clear: ECB IS EXTREME PANIC

kaiserhoff's picture

I never knew Sinn was a German name.  Played in a band with a guy named Royal Sinn.

Always thought his parents must have been a little..., different;)

knukles's picture

Well, I guess that now we can "bank" on deflation, no?

KnuckleDragger-X's picture

The ECB reminds me of aeronautical enginneers a few decades ago who started using computer modeling and conclusively proved that bumblebee''s cannot possibly fly.

radiobomb's picture

thanks ekm1, good info

Bernoulli's picture

He is a really good at explaining difficult topics, even energy strategy or other macro subjects.

Unfortunately, the majority of Germans don't listen to him.

malek's picture

"Nun kommen Sie mir doch nicht mit Fakten!" </Otto>

fockewulf190's picture

"Unfortunately, the majority of Germans don't listen to him."

He always make sense when he is interviewed in the media, but what he has to say is not what the government wants the public to hear.  Needless to say, he isn´t given nearly enough exposure.  I would change your statement to read "Unfortunately, the majority of Germans haven´t listened to him." That would be more accurate.

It´s the same deal when it comes to Deutsche Bank and it´s derivatives exposure of over $50 trillion.  I´d be surprised if 1/2 of 1% of Germans even know that fact.  Why do so few know about this?  Because it´s not talked about.  Not from politicians, and not from the MSM.  The last thing they want to deal with is an informed public.

Bernoulli's picture

I'd be surprised if 1/2 of 1% of Germans have ever hear the words "derivative" or "netting", let alone understand that 50 trillion exposure dwarfs the German GDP and could fuck up the whole worlds' financial system.

The Germans I know tell me: "Hey dude, we are doing pretty fine! Merkel does a good job defending our interests!"

And then when the shit will hit the fan, you bet they will find somebody else to blame. Nice way to stay in the comfort zone. Much better than waking up one day and having to deal with the fact that the whole system around you is a complete lie.

Cast Iron Skillet's picture

Many Germans suffer from confirmation bias just like many Americans. They WANT to believe that everything is fine, and do not want to see the negative handwriting on the wall.

THE DORK OF CORK's picture

"if southern European countries are to regain competitiveness without euro-zone inflation. He added that regaining that competitiveness solely via inflation in north - something Germany clearly is not too crazy about - would violate ECB mandate"


Except the problems in Europe were caused by a drive towards competitiveness.

What is competitivess ?

Its really the ability to export your wealth.

Be this real goods exports or tourists burning your local resources.


Whats  perhaps more important for a economy is local exchange.

This local exchange was first subtracted by national policies and later totally destroyed by the euro experiment.

We can see this clearly  today -   Euro roboten can no longer afford local goods , in most cases local goods no longer exist.

Time to tell the Germans something simple but profound.

"There is no wine"



Wolferl's picture

@ Dork


There is a lot of wine. And there will be even more wine for Germany if and when the others will start to leave the Euro because the Germans will be able to buy up the assets of the others for cheap. But don´t forget, the Euro is NOT a German project but was introduced by others to control Germany. Now that´s what i call shootin yourself in the foot, n'est-ce pas?

kowalli's picture

hang them up immediately

THE DORK OF CORK's picture


Example -  If  Spain becomes more "competitive" more Northern european people can burn its resource ration.  


Not a good deal for Spanish residents.

Imagine the size of the UK energy & real goods deficit if its Pensioners cannot go to Spain this time of year..............

nakki's picture

I don't think you need charts to crush all credibility, from any central bank. 

Bernoulli's picture

I am afraid the ECB  will spin this differently:

- ECB mandate is to "control" inflation (and avoid deflation)

- They say they will do "whatever it takes" to reach their inflation goal of 2%

- Banks CAN unfortunately NOT survive in a deflation scenario, therefore the 2% inflation goal becomes now even more important than before

- This AQR will be presented as "proof" that all is fine - IN CASE inflation will be going towards 2%, i.e. there will be no deflation

- Therefore this "stress test" will serve as license for the ECB to print money like never seen before or as a blackmail for example towards the Germans ("Hey Germans, do you know what happens to Deutsche Bank in case of deflation scenario? Yes, exactly. So now shut up and sign down here!")


Wolferl's picture

2% inflation is INFLATION. Actually it´s the mandate of the ECB to fight those 2% inflation. The ECB mandate is PRICE-STABILITY, and 2% inflation is not price-stability. If they say they have a 2% inflation goal they are actually violating their mandate and should be removed from their offices.


And Deutsche Bank can go to hell if necessary, it´s nothing but an Anglo-American bankster outfit we don´t need in Germany anyway.

Bernoulli's picture

Agree. And they can all go to hell, not only DB.

But concerning "price stability": Can you imagine any CB plan with 0% inflation? And how would the 3% budget deficit rule look in a scenario of 0% inflation, for example?

Exactly. The whole EU would be fucked.

Therefore, Mario D. will print his ass off... CTRL + P all the way to Zimbabwe...

And they will use 2% inflation target and AQR as excuses to sell this to everybody.

Wolferl's picture

The ECB has a mandate for 0% inflation. Even if it´s clear that you will have some low inflation rates in the Eurozone over the years. And countries will have to learn what living with a hard currency really means. And that´s not only a problem of governments but of people. I´m doing business with people from Italy a lot and they still don´t get it after 15 years in the Euro now. They still think it´s normal to raise prices for their product every year when it´s in fact necessary to lower the price in a near deflationary eviroment. To be able to do this you have to work harder, refine your production methods and lower costs and be more innovative. But it´s a deep rooted cultural thing in many European countries that this is not necesarry. I think things have to get a lot worse in some countries here in Europe till they finally see what´s the new reality.

Ghordius's picture

+1, Wolferl though I disagree on two things:

first, about the Southerners not being able to adjust to stable prices. it just neglects to mention that it's really, really hard, as hard as the currency that behaves this way. and so it takes time. remember that small and medium businesses are fast in many things, and slow in other, and this is a point where they are usually slow. there is a big difference between firing 7'000 and/or lowering the wages of other 7'000 in a megacompany of 70'000 and doing a similar manouver in a company of 700 or 70 or even 7. add to this that a megacompany does such manouvers in a quarter, while small and medium businesses think more in yearly terms

second, the precise ECB mandate is price stability, defined as prices rising between 0% and +2%, with a preference for near +2%

piratepiet's picture

Price stability means inflation of 0 percent.  If 2 percent is your goal, do not deceptively call it price stability.   

They might control finance, but they do not own language or logic. 

jubber's picture

and Europe gaps up LOL

tuttisaluti's picture

they just have to change the way how they measure inflation and voila, everything is fixed.


Stained Class's picture

Can the ECB buy crude oil futures?

KnuckleDragger-X's picture

they would bet in the wrong direction for sure....

Ghordius's picture

why not buy oil and oil storage facilities, at that point?

GodHelpAmerica's picture

But suppose these short term "inflationary policies" last far longer than they are intended. And then suppose, that the longer they last the worse the impact on inflation, i.e. the correlation turns negative, as QE, ZIRP and NIRP destory the global economy. I believe the biggest misconception now being widely accepted by policy makers and investors (speculators) alike, is that they will get their benign inflation numbers by doing more of the same, when more of the same is pushing their goal post further and further away (see the US money velocity). None of these policies will yield the desired result--this benign wage-pull inflation, they're praying for, which will magically come to fruition by a healthy and growing labor market, is now clearly in fantasy land. Just look at the data. Most of us here at Zerohedge knew this years ago, but now even the morons can see for themselves, with several years worth of data to work with--that NONE OF THIS IS WORKING, and currently looks to bring about the exact opposite of the intended outcome.

To me, barring a Helicopter drop of fiat currencies to the masses, we are destined for short term deflation (in most markets--especially equities), followed by severe Western currency weakness, which will rapidly inflate all goods/commodities not directly linked to economic growth.

Cautiously Pessimistic's picture

Central Banks of the world ... a POX upon thee!

AdvancingTime's picture

I take this as more proof the euro-zone is in a far bigger mess than recent headlines and figures suggest. Most of the growth in the Euro-zone over recent years has been in Germany and that bright spot is now under pressure. Italy has been in recession for two years; France’s economy has been stagnant for months. Now that Germany is in trouble, many economist think the chances of a Japan-style deflationary spiral have risen sharply.

What it all boils down to is Germany can’t keep buying Greek bonds and other bad debt with German taxpayer money until the end of time. The article below looks at the corner Central banks have painted economies into by attempting to paper over reality and how these polices will hinders growth for as long as the eye can see.

Ewtman's picture

Inflation or deflation? The answer is, and has been for a long time, quite clear.


Notsobadwlad's picture

Don't they understand that as debt increases people spend less?

As people spend less, less needs to be produced and there is greater competition.

With greater competition for sales there is downward price pressure ... which leads to deflation.

famulus's picture

the next of kin of a napkin is a piece of toilet paper, both used as writing papers by the ecb