Sabotage at the ECB

Emily Nicol
Chris Scicluna

Overview:
The mood in Europe’s markets is dire again this morning, with stocks down more than 3% in the largest markets and the euro area bond sell off continuing. Indeed, yields on 10Y Bunds areup more than 15bps again to about -0.28%, the highest since mid-January and more than 60bps above the recent trough. And periphery bonds are taking a kicking, with yields on BTPs up 50bps on more across the curve, with 2Y yields up above 2.00%, more than 200bps above their level a fortnight ago and the highest since 2018.

The cause for the turbulence in bond markets has been some further disastrous communication from the ECB. While recent days had seen various Governing Council members seek to douse the flames caused by Christine Lagarde’s careless talk last Thursday – when she triggered the euro area bond market sell-off by denying that the ECB had an interest in narrowing spreads – an irresponsible and seemingly deliberately inflammatory interview from the Austrian central bank governor Holzmann published this morning undid their work in a flash.

Among other things, Holzmann tried to insist that there had been unanimous support for Lagarde’s comments; that (contrary to the Governing Council’s forward guidance) ECB monetary policy had now reached its limit; and, perhaps most crassly and insensitively in the current circumstances, that “every crisis is a cleansing”.

In response, the ECB issued a rushed statement to try to counter Holzmann’s comments, noting that it “stands ready to adjust all of its measures, as appropriate, should this be needed to safeguard liquidity conditions in the banking system and to ensure the smooth transmission of its monetary policy in all jurisdictions”. But at present, while other major central banks are actively trying to ease market strains, the ECB is very much part of the problem, not the solution.

Indeed, following yesterday’s action from governments to try to ease economic and financial strains, Holzmann’s interview smacks of sabotage. And as the coronavirus takes a much greater toll on economic activity, despite the support being provided by member state governments, the ECB needs to respond with more than just a statement of clarification. A decision to increase its public sector bond purchases to a level that requires the lifting of its self-imposed issue and issuer limits would seem in order sooner rather than later. But ultimately, unless the member states move swiftly to preparing a common euro area ‘coronabond’ – a notion that Merkel yesterday refused to rule out – a form of ECB yield curve control, perhaps incorporating activation of the OMT programme and an ESM package too for Italy others too, might well also be required.

So, those comments from Holzmann undid the positive impact of the new proposals from yesterday's announcements of government support packages, which had appeared rather more commensurate to the financial challenges posed by the coronavirus. Among others, France’s Finance Minister Le Maire unveiled a package of €45bn (close to 2% of GDP) of extra spending and tax deferrals on top of €300bn (more than 10% of GDP) of loan guarantees, and raised the prospect of extra funds for recapitalizing and/or nationalizing firms. Spain’s PM Sanchez proposed €17bn (likewise more than 1½% of GDP) of extra direct spending and tax deferrals, and €100bn (8% of GDP) of loan guarantees. And UK Chancellor Sunak followed last week’s budget announcement of extra spending and tax measures with his own plans for £330bn (near 15% of GDP) of loan guarantees.

But most attention on the fiscal front yesterday was focussed on the US, where the Mnuchin proposals could reach $1.2trn (more than 5½% of GDP) and look set to include means-tested direct payments to households. That news also followed confirmation that the Fed had delved into its crisis toolkit once again to reintroduce its Commercial Paper Funding Facility to support short-term dollar funding markets. In particular, benefiting from $10bn of credit protection from the Treasury, the CPFF will offer a liquidity backstop to US issuers of commercial paper through a new SPV to buy unsecured and asset-backed CP directly from eligible companies.

Against that backdrop, US stocks rebounded somewhat. But while it looked big, yesterday’s 6.0% gain in the S&P500 still left it below Monday’s intra-day peak and less than half of the way to Friday’s close. And there was still no clear upwards momentum, with US futures down again so far today. Certainly, there remain doubts as to whether the responses of both fiscal and monetary policy in the US let alone elsewhere will suffice.

Indeed, most Asian stock indices closed lower today, e.g. Korea’s KOSPI ended the day down almost 5.0% even though the National assembly approved the government’s latest fiscal package. Japan’s TOPIX, however, ended the day up 0.2% as PM Abe was reportedly set to establish a panel to discuss new support measures (with the opposition calling for a reversal of October’s sales tax hike) and after data confirmed that the BoJ had yesterday bought a record ¥121.6bn of ETFs (about 20% more than the previous maximum) following Monday’s decision to double the annual targeted rate of increase in its holdings to ¥12trn. The latest trade data out of Japan, meanwhile, gave an insight into the effect of China’s coronavirus shutdown on export demand (see below).

And despite the backdrop of volatile equities, beyond the euro area the bond market sell-off continues too. Having jumped more than 35bps yesterday, 10Y UST yields have risen further this morning to above 1.20%, almost 90bps above last week’s trough. JGBs were also weaker across the curve again today, with 10Y yields up more than 4bps to around 0.05%, the highest since late last year. And ahead of tomorrow’s RBA announcement – where a 25bps cut in the Australian cash rate to its effective floor of 0.25% is likely to be accompanied by a move to yield curve control at shorter maturities – ACGBs sold off again at the longer end (10Yyields up 17bps to 1.17%) but were little changed up to 3Y.

Japan:
The overnight release of Japan’s goods trade report for February unsurprisingly revealed an impact of the coronavirus on activity. At face value, however, Japan’s export performance was stronger than might have been expected, particularly in light of China’s woeful activity figures published earlier in the week (e.g. IP down 13½%YTD/Y, retail sales down 20½%YTD/Y). Indeed, the value of Japanese exports was up 3.4%M/M in February, to leave them down just 1%Y/Y, the softest annual decline since November 2018. And the drop in exports to China was much smaller than feared (-0.4%Y/Y).

Of course, these figures are likely to have been flattered to some extent by the timing of the Lunar New Year. But there were hints that demand for Japanese goods had been boosted by supply constraints in China – e.g. total shipments of electrical machinery were up almost 10%Y/Y while there an increase of more than 23%Y/Y in exports of semiconductors. Indeed, shipments to Taiwan were up 11%Y/Y, while there was the first positive growth in exports to South Korea since October 2018 and the strongest for the more than two years. So, overall, exports to Asia were up 1.7%Y/Y. Demand from elsewhere, however, remained subdued, with shipments to the US down more than 2½%Y/Y and down more than 7½%Y/Y to the EU.

When looking at the performance since the start of the year, however, exports have been undeniably weak. Indeed, adjusting for seasonal and price effects, the BoJ’s measure of export volumes so far in Q1 are currently trending almost 2% lower than the Q4 average despite a more than 4%M/M increase in February. And so goods exports seem bound to be a notable drag on GDP growth in Q120.

This notwithstanding, Japan recorded the largest trade surplus (¥1.1trn) since September 2007 as a collapse in imports reflected a significant hit to supply. Indeed, imports were down a whopping 10.7%M/M, to leave them down more than 17%Y/Y, with imports from China were down by almost 50%Y/Y, the most since the series began in the early 1990s. But with the volume of imports down from the EU and US too, today’s report suggests that subdued domestic demand was also a factor. And with this likely to worsen over coming months, we expect imports to remain very weak. Indeed, in January and February import volumes were on average almost 7½% lower than the average in Q4.

Accordingly, despite the anticipated drag from exports, net goods trade seems likely to provide a welcome boost to GDP growth in Q1. Of course, it remains to be seen to what extent this will be offset by services trade. But tomorrow’s release of overseas visitor numbers for February seems bound to flag the likely significant drag from tourism spending in Q1.

Euro area:
The news-flow from the autos sector remains dire, with BMW now added to the list (including VW, Daimler, Nissan and Ford) of firms in the sector to cease production over coming weeks. And this morning’s release of EU car registrations figures for February inevitably revealed a further notable drop in demand in then region. In particular, new registrations in the euro area fell 6.7%Y/Y to 838,889 units, the lowest February reading for five years. This reflected notable weakening in the four largest member states, with new registrations in Germany down 11%Y/Y, in France down 2.7%Y/Y, Italy fell 9%Y/Y, and Spain fell 6%Y/Y. Taken together with the weakness seen in January, this left total euro area registrations down 6.9%YTD/Y, the steepest such decline since 2013. And with much of Europe now in lockdown, this seems bound to get much worse in the final month of Q1 and into Q2 too.

This morning will also bring final euro area inflation figures for February, which are likely to align with the flash estimates, at 1.2%Y/Y for both headline and core rates. But these seem bound to fall sharply from March onwards due to the plunge in oil prices and broader shock to demand from the coronavirus. January’s euro area trade figures are also due, but likewise won’t be representative of current challenges. In the markets, Germany will sell 30Y bonds.

UK:
While it should be quiet for new UK economic data, today should bring further information on the specific details of yesterday’s fiscal stimulus package – including £330bn (about 13% of GDP) of loan guarantees – announced to support businesses and individuals in the face of an increasingly uncertainty economic environment. In particular, the Bank of England will publish further details of the operation of the associated Covid Corporate Financing Facility (CCFF) where it will provide funding to businesses by purchasing commercial paper of up to one-year maturity, issued by firms making a material contribution to the UK economy.

US:
In the US, today will bring housing starts figures for February.

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