At Thursday’s presser, Mario Draghi telegraphed more easing from the ECB come December.
This wasn’t exactly a surprise. In fact, some observers had expected Draghi to expand PSPP at the September meeting and although the market was disappointed in that regard, the ECB did raise the issue limit from 25% to 33% effectively giving themselves more dry powder.
The question now, is what exactly the ECB will announce. That is, will Draghi cut the depo rate further into negative territory thus setting off a chain reaction for the Riksbank and the SNB and thus raising the spectre of NIRP for retail depositors?
How long into 2017 will PSPP be extended?
Given the scarcity of purchasable paper, will the ECB expand the universe of eligible assets and if so, will Draghi go full-Kuroda knowing full well that you never, ever go full-Kuroda?
All good questions, and ones we suspect many a sellside strategist will attempt to answer in the weeks ahead. For his part, RBS’ Alberto Gallo is out with a rundown of the ECB’s options and not only are non-financial corporate bonds on the list (something we predicted months ago), but so are (gasp) stocks, suggesting that the ECB may soon embark on a Japan-style effort to corner the equity market along with the government bond market.
First, Gallo notes the ECB’s mention of the SNB (another central bank which, like Japan, is sitting on a hundred billion dollar equity book):
Yesterday the ECB prepared the ground for more easing in December, as we expected. What was surprising was the post-meeting Q&A, which went into more detail on the possibilities for easing, and even made a direct comparison with the Swiss National Bank – currently the central bank with the largest balance sheet as % of GDP (90%) in developed markets.
Next, RBS suggests that we should take the ECB quite literally when they say that they are “open to a whole menu of monetary policy instruments”:
All options considered means non-financial credit, wholesale loans, subsovereigns, and even equities. We have already outlined that expanding purchases to other types of credit could theoretically double the pool of the ECB’s purchasable bonds, to almost €19tn.
Adding more utilities or state-backed corporates is a logical step, but it is not going to give the ECB much further room. The ECB could decide to go further into the pool of € non-financial corporate bonds (€893bn) rated BBB and above, including € bonds from non-Eurozone issuers (€687bn excluding non-Eurozone issuers).
Adding equities would be particularly aggressive, offering a further €7tn of purchasable assets.
Then there’s the possibility of buying muni bonds:
Sub-sovereign bonds are another option, adding €336bn of local government bonds to the pool of assets. Sub-sovereign bonds account for around 3% of Eurozone GDP (this is small compared with the US, where municipal bonds are 21% of GDP).
And finally, in what might be looked upon as an even more outlandish move than buying equities, the ECB could simply buy individual personal loans from banks because apparently, doing so indirectly via ABS purchases hasn’t worked:
One incentive for the ECB to launch the ABS purchase programme last year was likely to encourage securitisation, helping banks to deconsolidate their balance sheets and unlock new lending. But securitisation issuance hasn’t picked up (see SIFMA data). This is partly due to the lack of harmonisation of national-level rules, the harsh capital treatment even for simple securitisations and the lack of government support (no guarantees to mezzanine tranches, even though the ECB can now buy guaranteed mezzanine tranches through ABSPP). Given the stagnant developments in the securitisation market, the ECB could instead start to buy loans directly to better target easing at the real economy. There are practical hurdles to loan purchases – illiquidity, lack of transparency, long settlement periods.
Yes, “practical hurdles” like “illiquidity, lack of transparency, long settlement periods” ... and let’s not forget “the public perception that the Gods must be crazy”, which is precisely what people would think once they learned that a developed market central bank had begun buying individual borrowers’ car loans from banks.
Just how large could this program ultimately get, you ask? Well, you're in the pee wee league if you're a central bank and your balance sheet doesn't sum to a respectable percentage of GDP and on that measure, the ECB has a long way to go:
The SNB has a balance sheet equivalent to 90% of GDP, the highest amongst major developed economies (see chart above). Taken that as a theoretical ceiling, the ECB could further expand its balance sheet by another 70% of GDP, i.e. over three times what they have done so far.
Of course none of this is going to work. As we've seen in Japan, you can monetize assets until the cows come home (indeed, until you break the market), but virtually all of the evidence from the global, post-crisis experiment in unconventional monetary policy suggests that you will have i) little to no effect on inflation expectations, and ii) a muted effect at best on aggregate demand. In fact, one would think that the ECB would have learned something from the fact that they've been buying bonds since early March and the bloc is now back in deflation.
In the end, all that will happen is the EMU's neighbors will be forced further into NIRP and the ECB will end up with a nightmarish balance sheet full of stocks, corporate credit, munis, and God only knows what kind of loans purchased from banks, and all of which will have been bought at or near the top. As Gallo notes, "the larger the balance sheet and the riskier the assets a central bank buys, the higher the potential for losses".
Indeed, and that sets up the possibility that central banks could end up being forced to operate from a negative equity position. In other words: it sets up the possibility that they'll technically go broke. As for what happens next, we'll leave that for another post.