$ES_F MOC SELL $650mil $$
$ES_F SPX moc implied imbal $1.3B for SALE $$
$ES_F 02:34:26 TRADINGDATA2: (bshepard) ESM moving the the favored direction of the imbalalce meter ... down $$
$ES_F 81% sell side $$
John_Monaco (13:41:50): 75% sell side on the close
One day after Germany's second largest lender confirmed reports of a massive restructuring when it announced it would lay off nearly 10,000 employees, or about 20% of its entire workforce while slashing the bank's dividend for the rest of the year, the Dutch newspaper Het Financieele Dagblad reported that ING Groep, the largest Netherlands lender, will announce thousands of job cuts at its investor day on Monday.
The reorganization will result in more central management and may generate billions of euros in savings, the paper said cited by Bloomberg. Raymond Vermeulen, a spokesman for the Amsterdam-based bank, declined to comment on the report. The bank employs about 52,000 people, according to its website.
ING sees opportunities in Belgium, the Netherlands, Germany and Poland, Het Financieele Dagblad said. The lender has doubts about its presence in Turkey, where it lacks scale, according to the report.
Chief Executive Officer Ralph Hamers has transformed ING into a bank focused on Europe and is seeking to expand lending to consumers and companies outside its home market as record-low interest rates and regulatory demands to bolster capital threaten to erode profit.
With all European banks struggling to generate profits under Europe's NIRP policy which makes net interest margin-based revenue virtually non-existent, we expect many more banks will be forced to lay off tens of thousands of more high paying jobs in the months ahead, leading to further declines in consumption, which in turn will pressure Europe's deflationary forces, even though earlier today Eurostat reported that inflation in the European Union rose to 0.4% in September, in line with expectations, and the highest since 2014.
Global stocks continued their selloff this morning, driven by surging speculation about the liquidity, solvency and viability of Deutsche Bank, which plunged 9% after opening in German trading today, dropping to a new all time single-digit low of €9.90, its credit default swaps soared to new all time highs, and its Additional Tier 1 notes fell to record lows (the €1.75BN of 6% bonds dropped five cents on the euro to 70 cents), although losses were cut in half after yet another memo by CEO John Cryan sought to reassure the bank's employees and investors...
Morning Note: 1. Some DB clients reduce exposure. 2. Cryan says everything is ok. 3. Investors remain clueless pic.twitter.com/geKbPSyTRO
— Jonathan Ferro (@FerroTV) September 30, 2016
... although we doubt this latest pep talk will lead to a sustained rebound, since there has been no talk yet of what the undercapitalized (by as much as €8 billion according to Citigroup) Deutsche Bank) need most of all, namely a capital raise. “Deutsche certainly weighs on sentiment, and the declines are concerning,” said James Woods, a strategist at Rivkin Securities in Sydney. “Being named the number one bank for global systemic risk, it’s entwined with everyone.”
The rebound in DB also helped US equity futures rise from session lows, when they slid as much as half a percent, before rebounding to -0.2% at last check. More troubling for the global financial system is that the DB contargion has now well and truly spread, as banking shares across Europe led losses in global stocks. Meanwhile, the dollar strengthened with government bonds while gold rose for the first time in four days as investors poured into haven assets.
As Bloomberg summarizes the last day of Q3, "what’s set to be the best quarter of the year for global stocks is ending on a sour note as concern mounts over Deutsche Bank’s ability to withstand pending legal penalties and hedge funds reduce their financial exposure. While its shares have more than halved in value this year and cross-currency swaps show the biggest weekly increase in two years, systemic concerns have a way to go to reach levels sparked by the collapse of Lehman Brothers Holdings Inc. in 2008 after regulators and central banks took steps to shore up the financial system."
The tension in the markets is well-known and was summarized by Valentin Marinov, the head of G10 currency strategy at Credit Agricole, who told Bloomberg that “Markets are spooked by the stories about clients cutting exposure to the troubled German lender. The risk is that, with the European Central Bank running out of options to ease, they may struggle to contain another market turmoil."
Elsewhere across global markets, the MSCI All-Country World Index slid 0.6 % as of 6 a.m. in New York, paring this quarter’s advance to 4%. The Stoxx Europe 600 Index slid 0.9 percent. Commerzbank AG lost 5.4%, as HSBC Holdings Plc downgraded the lender to hold, saying its new strategy announced Thursday isn’t convincing. ING Groep NV dropped 2.5% after a report that the largest Dutch lender will announce thousands of job cuts next week.
Telefonica SA lost 4.6 percent after canceling an initial public offering of its infrastructure unit Telxius Telecom SA, amid weak investor demand. S&P 500 Index futures were little changed. Investors will look Friday to data on consumer spending, sentiment and Chicago-area manufacturing for indications of the health of the world’s biggest economy. Hong Kong shares led losses in Asia with the city’s stock-exchange link to Shanghai having already closed before a week-long holiday in China. Inflows via the channel helped drive a 12 percent gain in the Hang Seng Index this quarter, the region’s best performance.
Looking at the bond market, Europe’s highest rated bonds advanced as investors opted for their relative safety. German bunds were set for their third week of gains. The yield on the 10-year bund fell three basis points, or 0.03 percentage point, to minus 0.15 percent, having earlier reached minus 0.16 percent which matched the lowest since July. The yield has dropped 15 basis since the week ended Sept. 9. Gains in euro-area bonds have driven the total number of securities in the region yielding less than the European Central Bank’s deposit rate of minus 0.4 percent to more than $2 trillion, which is more than a third of the total number of bonds comprising the Bloomberg Eurozone Sovereign Bond Index.
- S&P 500 futures down 0.2% to 2145
- Stoxx 600 down 0.9% to 339
- FTSE 100 down 1% to 6851
- DAX down 1.2% to 10286
- German 10Yr yield down 3bps to -0.15%
- Italian 10Yr yield up less than 1bp to 1.21%
- Spanish 10Yr yield down less than 1bp to 0.91%
- S&P GSCI Index down 0.7% to 360.9
- MSCI Asia Pacific down 1% to 140
- Nikkei 225 down 1.5% to 16450
- Hang Seng down 1.9% to 23297
- Shanghai Composite up 0.2% to 3005
- S&P/ASX 200 down 0.6% to 5436
- US 10-yr yield down 2bps to 1.54%
- Dollar Index up 0.19% to 95.72
- WTI Crude futures down 1.1% to $47.31
- Brent Futures down 1.2% to $48.66
- Gold spot up 0.5% to $1,326
- Silver spot up 0.8% to $19.27
Top Global Headlines
- Deutsche Bank Slumps as Some Hedge Fund Clients Reduce Exposure: Millennium, Capula among counterparties shifting positions. Bank’s CEO Cryan has ruled out state aid, capital increase
- Volatility Hedge Fund Sees Bull Market in Fear as VIX Bets Jump: Trading of VIX futures is on course for a record year. Investors are paying highest prices since 2012 for protection
- Salesforce to Urge Regulators to Examine Microsoft-LinkedIn: Deal threatens innovation and competition, Salesforce says. Extended review of acquisition could delay approval for months
- Qualcomm Stock Surges on Report of Interest in Acquiring NXP: NXP would allow Qualcomm to diversify away from smartphones. Target is largest maker of semiconductors used in cars
* * *
Looking at regional markets, we start in Asia where stocks traded mostly lower following the losses on Wall St. where sentiment was dragged down by further Deutsche Bank woes. This dampened the financial sectors in ASX 200 (-0.7%) and Nikkei 225 (-1.5%) with the latter also suffering after slew of mostly discouraging data in which Unemployment rose, CPI remained subdued and Household Spending fell by the most in 5 months. Chinese markets were mixed with Hang Seng (-1.9%) conforming to the widespread downbeat tone, while Shanghai Comp. (+0.2%) was resilient as participants digested a mild improvement in activity with China Caixin PMI figures printing in line with estimates at 50.1 (Prey. 50.0). 10yr JGBs traded lower despite the risk averse sentiment in Japan with pressure seen after a weaker bond buying operation by the BoJ.
Top Asian News
- PBOC Pulls Most Funds Since July Amid Leverage Curb Speculation: Adds to pressure from quarter-end, holiday demand for money
- China’s Big Political Gambit Hinges on a Remote Arabian Sea Port: Mountains, disputed territory and armed rebels lie in the way of China’s route
- Alarm Bells Sound in New York as Duterte’s Audit Roils Mines: OceanaGold CEO says “investors are very worried” about country
- India Seeks to Curb Tensions After Raid Over Pakistan Border: No plan to escalate situation by scrapping Pakistan treaties
- Data Deluge Shows Japan’s Economy Sputters on as Prices Fall: Industrial production offered bright spot for Japan in August
The sell-off in Deutsche Bank (-7%) has dragged the share price to 30 year lows leading financials and European bourses (Dax -1.5%) into the red, the most recent sell-off came after hedge funds had reportedly reduced their exposure to the lender. This has subsequently led the Co.'s CEO to state that market forces are attempting to undermine the bank in a letter to employees. The woes for Deutsche haven't been isolated to Deutsche with the likes of Commerzbank, Barclays, Credit Suisse and Santander all feeling the squeeze, to name a few. Elsewhere, energy names are softer amid the pullback seen in WTI and Brent but losses are modest in comparison to those seen in the banking sector. In fixed income, the main theme on the menu has been risk-aversion which has subsequently supported prices with little in the way of supply for today's session.
Top European News
- Fate of Italy’s Economy at Risk If Renzi’s Key Referendum Fails: Growth harmed without budget measures, prime minister signals. Finnish central bank says Rome weakness worrying like Brexit
- H&M Warns Weak September Sales May Erode Fourth-Quarter Profit: Revenue growth slows to 1%, slowest pace in 13 months. Retailer plans to introduce as many as 2 brands next year
- Apple, Irish Said to Claim EU Kept Them in Dark Over Tax: Duo to argue in court that EU failed to explain probe U- turn. EU says it communicated fully and didn’t change tack in case
- ING Shares Fall After Report Thousands of Jobs to Be Cut: ING Groep NV, the largest Dutch lender, fell the most in two months in Amsterdam trading after a report that the company will announce thousands of job cuts next week
In FX, The Bloomberg Dollar Spot Index rose 0.2 percent. The pound advanced against most of its major peers and was on course for its first weekly gain versus the euro since Sept. 2. The yen appreciated 0.3 percent to 113.03 to the euro extending a three-week advance of 2.3 percent since Sept. 2. India’s rupee was the best-performing emerging-market currency as the nation and Pakistan moved to contain military tensions after Prime Minister Narendra Modi’s administration announced it killed terrorists just across the border. The cost for European banks to fund in dollars, a gauge of risk in the region’s financial system, rose to the most expensive level in more than four years amid Deutsche Bank’s woes. The three-month cross-currency basis swap, the rate for banks to convert euro payments into dollars, fell to 57 basis points, or 0.57 percentage point, below the euro interbank-offered rate, according to data from ICAP Plc. That’s the most negative reading on a closing basis since July 2012. The measure reached as much as 154.5 basis points below Euribor in November 2011. While so-called FRA/OIS spreads, a measure of bank risk, were set for their biggest weekly jump since June, the front contract was at a record low as recently as two weeks ago.
In commodities, gold rose 0.4 percent to $1,326.30 an ounce. Following the best first half in 40 years, interest in the metal has waned as prices barely budged in the second quarter. The 60-day volatility is near the lowest in more than a year and the amount of metal added to exchange-traded funds has slowed. Holdings backed by gold have climbed 4 percent this quarter after jumping 21 percent in the first three months of the year and 11 percent in the second quarter. Crude oil fell 1.3 percent to $47.22 a barrel in New York, after gaining more than 7 percent over the last two days. While Wednesday’s agreement among Organization of Petroleum Exporting Countries imposed an overall production cap on the group of 14 oil producers, it didn’t assign individual limits -- that was left to a committee that will report back at OPEC’s next meeting in November. “It’s good that OPEC is going to limit production but sticking to the deal is the big headwind facing the organization,” said David Lennox, a resources analyst at Fat Prophets in Sydney. “We’re yet to get the exact details on which countries will contribute the cut, but the Saudis could handle that on their own without too much hassle.”
On today's calendar, the highlight will likely be the personal income and spending reports for August (market consensus is for +0.2% mom and +0.1% mom respectively) along with last month’s August PCE core and deflator prints. We’ll also get the latest Chicago PMI, followed lastly by the final September revision for the University of Michigan consumer sentiment reading. Away from the data, the Fed’s Kaplan is due to speak this evening at 6pm BST.
* * *
Bulletin Headline Summary from RanSquawk and Bloomberg
- Deutsche Bank woes continue to grip the market, sending European equites lower once again
- Risk off has been then running theme in FX this morning, with the likes of AUD and CAD under pressure while JPY and CHF buying has followed suit
- Looking ahead, Highlights include Chicago PMI, University of Michigan Sentiment & a Speech from Fed's Kaplan
US Event Calendar
- 8:30am: Personal Income, Aug., est. 0.2% (prior 0.4%)
- 9:45am: Chicago Purchasing Manager, Sept., est. 52 (prior 51.5)
- 10am: University of Michigan Sentiment, Sept. F, est. 90 (prior 89.8)
- 1pm: Baker Hughes rig count
* * *
DB's Jim Reid completes the overnight wrap
As the dust settled yesterday from the OPEC news it seemed to become fairly clear quite quickly that there is still plenty of doubt amongst investors about the actual willingness of OPEC to follow through on their word and agree on the finer details. While Oil (+1.66%) edged a bit higher yesterday, and at one stage saw WTI break above $48/bbl for the first time in two weeks, markets elsewhere have seemingly moved on to other things as negative headlines around the European banking sector reverberated across the wires and so sent financials lower, and the healthcare sector buckled under pressure on lingering regulatory concerns. The end result saw the S&P 500 (-0.93%) more than wipe out the previous day gain, while the Stoxx 600 (+0.04%) wiped out an early rally of more than 1%, despite the energy sector surging nearly 5%. The bid continued for Treasuries with the 10y yield down another basis point to 1.561% while the Greenback and Gold also bounced off the early intraday lows.
Before we go any further, it’s been a busy morning in Asia and especially in Japan where a flurry of data has been released alongside the BoJ summary of opinions from the meeting last week. Starting with the data, there is little sign of deflationary pressures abating for the BoJ with headline CPI nudging further lower last month to -0.5% yoy from -0.4% in July. That’s the lowest reading since April 2013. The core remained at -0.5% yoy (vs. -0.4% expected) and the core-core fell one-tenth to +0.2% yoy as expected. On a seasonally adjusted month on month basis, headline CPI was -0.1% while the two core readings were flat. Overall household spending (-4.6% yoy vs. -2.1% expected) also disappointed. Meanwhile, the jobless rate crept up to +3.1% in August from +3.0% although it continues to hover around historically low levels, while the one bright spot of this morning’s data dump was industrial production (+1.5% mom vs. +0.5% expected).
In terms of the BoJ minutes, the summary of opinions showed that the board will continue to examine an appropriate shape of the yield curve at every monetary policy meeting. The text also revealed that the BoJ felt that it was ‘imperative’ to ensure the sustainability of monetary easing and that the ‘inflation-overshooting commitment’ and ‘yield curve control’ are a paradigm shift in monetary easing policy.
There should continue to be more focus on Japan this morning when, at about 9am BST, the BoJ is set to announce its outline of outright purchases of JGB’s for October. This will likely attract more interest than normal given that it is the first monthly JGB purchase plan since the introduction of QQE with yield curve control last week. Our strategists in Japan believe that it will be difficult for the Bank to keep its annual JGB balance increase at ¥80tn in 2017 and so they expect to see the start of gradual passive tapering in the near future. That said, they also expect the BoJ to maintain its October JGB purchase plan, adopting a wait and see attitude for next month. Any reduction in purchases though would likely be extensively seen as a start of tapering, which our strategists say risk yen appreciation and a decline in stocks. The October JGB purchasing plan is an important event to measure the BoJ’s stance for yield curve targeting, so it’s worth keeping an eye on the details.
In terms of what markets have done in Asia this morning, bourses in Japan are generally leading losses following that data with the Nikkei and Topix -1.55% and -1.51% respectively with financials in particular under pressure. Those losses have actually come despite a -0.40% weakening for the Yen. Meanwhile the Hang Seng (-1.19%), Kospi (-0.94%) and ASX (-0.67%) have also dipped lower. China is outperforming with the Shanghai Comp (+0.13%) a smidgen higher. That has come after the private Caixin manufacturing PMI for September edged up to 50.1 from 50.0. Elsewhere, Oil has given back about half a percent this morning.
Back to yesterday. In terms of the data, the main focus in the US was on the third revision to Q2 GDP. Growth was revised up from +1.1% to +1.4% qoq primarily as a result of slightly higher non-residential fixed investment and also less inventory destocking than what was previously reported. Meanwhile initial jobless claims (+3k to 254k) continued to underscore decent strength in the labour market with the four-week average ticking down now to 256k which is the joint lowest since November 1973. Elsewhere the advance goods trade deficit for August narrowed very modestly to $58.4bn while pending home sales came in a fair bit softer than expected last month (-2.4% mom vs. 0.0% expected).
There was a bit of Fedspeak yesterday too but once again nothing that appeared to be much of a change of view or market moving. The Atlanta Fed’s Lockhart (centrist) said that ‘a change in policy could occur before too long’ but that also ‘I did support the consensus view that, before taking the next move, it makes sense to see a little more evidence of progress toward our statutory policy objectives’. Meanwhile Philadelphia Fed President Harker said that ‘I tend to be in the camp of normalizing sooner, rather than later’ which is consistent with his more hawkish leaning.
Over in Europe yesterday, Germany reported a +0.1% mom increase in consumer prices this month after expectations were for no change, although the harmonized measure did come in at 0.0% mom. Euro area confidence indicators generally edged up this month with the economic confidence reading in particular printing 1.4pts higher at 104.9 (vs. 103.5 expected). Finally in the UK mortgage approvals (60.1k vs. 60.2k expected) were more or less in line but did decline from 60.9k in July and to the lowest level in nearly two years. Net consumer credit (£1.6bn vs. £1.4bn expected) remained fairly strong last month though.
Staying with Europe, yesterday DB’s Marco Stringa published a note on the key recent developments in Italy. He highlights that ahead of the Senate reform on December 4th, opinion polls remain too close to call and the proportion of undecided voters is also very large. He notes that some have interpreted Renzi's recent statements as a sign that even if the Senate reform is rejected he will not resign. Hence, a "No" vote would have less significant consequences than previously thought. Marco disagrees. He says that if the Senate reform is rejected, his central case scenario is that Renzi will resign and then he will either lead or just support a new government with limited scope – writing a new electoral law – and limited duration. The low likelihood but potentially high impact scenario in the case of a rejection of the Senate reform would be an immediate early election in Q1 2017 which would favour the anti-establishment 5SM. On the other hand, an approval of the Senate reform would probably be, at least in the short term, the most market friendly outcome, but it would be no panacea.
Looking at the day ahead, there’s a fair bit of data to get through in the European session this morning. In Germany the August retail sales data will be released a short time after this hits your emails, followed closely by UK house price data for September. CPI reports for France and also the Euro area will be due this morning along with the final Q2 GDP revisions in the UK. This afternoon in the US the highlight will likely be the personal income and spending reports for August (market consensus is for +0.2% mom and +0.1% mom respectively) along with last month’s August PCE core and deflator prints. We’ll also get the latest regional manufacturing survey in the form of the Chicago PMI, followed lastly by the final September revision for the University of Michigan consumer sentiment reading. Away from the data, the Fed’s Kaplan is due to speak this evening at 6pm BST.
Before we wrap up, early tomorrow morning the official manufacturing and non-manufacturing PMI’s will be released in China. Also of potential interest is Sunday’s scheduled referendum in Hungary where Hungarians will vote on the resettlement of refugees. The referendum is backed by Prime Minister Orban and will be the latest test of populist power. A 50% turnout is needed for the final outcome to be legally binding.
Instead of doing what many have correctly suggested he should be doing, namely focusing on ways to raise more capital for the undercapitalized Deutsche Bank in order to stem the slow (at first) liquidity leak, first thing this morning CEO John Cryan issued another morale-boosting note to employees of Deustche Bank who have been watching their stock price crash to another record low, dipping under €10 in early trading for the first time ever. In the memo the embattled CEO worryingly did what Dick Fuld and other chief executives did when they felt the situation slipping out of control, namely blaming evil "rumor-spreading" shorts, saying "our bank has become subject to speculation. Ongoing rumours are causing significant swings in our stock price. ... Trust is the foundation of banking. Some forces in the markets are currently trying to damage this trust."
Just as important, Cryan confirms the Bloomberg report that "a few of our hedge fund clients have reduced some activities with us. That is causing unjustified concerns." As we explained last night, the concerns are very much justified if they spread to the biggest risk-factor for the German bank: its depositors, which collectively hold over €550 billion in liquidity-providing instruments.
He then tries to sweep the concerns under the rug saying that "We should consider this in the context of the bigger picture: Deutsche Bank overall has more than 20 million clients." Of course, however by the time the "context" switches over to the rest of the clients, or even a small portion of them, namely the depositors, it would be too late as by then the retail bank run will have begun.
Finally, Cryan confirms that there has been a liquidity outflow, when he says that the bank's liquidity reserves currently "amount to more than 215 billion euros." Considering just last night we estimated the liquidity reserves were €223 billion as of June 30, it appears there has been a modest outflow, even when accounting for the recent disposal of the British insurer Abbey Life.
In other words, Cryan once again fails to provide a clear plan how he will short up the bank's deteriorating liquidity, no mention of a capital raise or approach of the ECB, and most importantly, no specifica plan how to recover crumbling trust in the world's "most systematically important bank."
Cryan concludes by saying "You will hear back from me soon." On this he is absolutely correct.
Cryan's full memo to employees released early this morning below:
John Cryan, Deutsche Bank CEO, sent out the following message to the Bank’s employees on September 30, 2016
You will have seen speculation in the media that a few of our hedge fund clients have reduced some activities with us. That is causing unjustified concerns. We should consider this in the context of the bigger picture: Deutsche Bank overall has more than 20 million clients.
I understand if you feel concerned by the extensive coverage on this issue. Our bank has become subject to speculation. Ongoing rumours are causing significant swings in our stock price.
It is our task now to prevent distorted perception from further interrupting our daily business. Trust is the foundation of banking. Some forces in the markets are currently trying to damage this trust.
Deutsche Bank has strong fundamentals. Let me mention some of the most important facts at this point:
1. We fulfil all current capital requirements and our restructuring is well on track. We completed the disposal of the British insurer Abbey Life this week and the sale of our stake in the Chinese Hua Xia Bank will be finalised soon. This will further improve our capital ratio.
2. We have significantly decreased our market and credit risk in recent years. At no point in the last two decades has the balance sheet of Deutsche Bank been as stable as it is today.
3. Despite low interest rates and a difficult environment we posted a pre-tax profit of about 1 billion euros in the first half of 2016. Before extraordinary items like restructuring costs, we earned about 1.7 billion euros. This demonstrates the operating strength of Deutsche Bank.
4. In a situation like this, the most important factor is our liquidity reserves. Currently they still amount to more than 215 billion euros. This is an extremely comfortable buffer. This is clear proof of how conservatively we have planned. This is acknowledged by numerous banking analysts.
There is therefore no basis for this speculation. Nor can uncertainty about the outcome of our litigation cases in the US explain this pressure on our stock price, if we take the settlements of our peers as a benchmark.
You have all done a tremendous job over the past few days. You are the ones who are in constant contact with our clients and making it clear how Deutsche Bank is really doing. You are Deutsche Bank – that is impressively clear. All of us in the Management Board highly appreciate it.
You will hear back from me soon. Please keep working as you have been doing so far. We are and we remain a strong Deutsche Bank.
- Debate about the ECB’s stimulus options have continued to rage, with an equity purchase plan mentioned as a possibility
- We think the ECB could legally buy ETFs that fit its requirements…
- … but it would be controversial and we question the benefits
- An ETF programme could total EUR 200bn, which would not be large compared to the overall QE programme
- …and assuming a market-weighted allocation, it would benefit the core more than the periphery…
- …while it is questionable whether it would have a major sustained impact on equity prices, economic growth and inflation
- The risk of losses is higher for equities than investment-grade credit
- Ultimately, we do not think that the ECB will follow other central banks and turn to buying equities via ETF purchases any time soon, if at all
We consider whether the ECB will turn to equity purchases
The ECB stepped up its unconventional policy around the middle of 2014, by taking its deposit rate into negative territory. Early in 2015, it launched a large-scale QE programme focused on public sector bonds. Since then it has added regional bonds and investment-grade credit bonds to the mix. Despite the positive effects on financial conditions, the outlook for growth and inflation remains disappointing. At the same time, there are market concerns that there are not enough bonds available to be bought and that current monetary policy is losing its effectiveness. This has led to questions about what else the ECB can add to its policy mix. In this research note, we consider whether the ECB will turn to equity purchases. We first look at whether equity purchases are possible from a legal and practical perspective and what such a programme could look like. We then go on to assess how effective buying equities would be in boosting equity prices, and hence growth and inflation, drawing on the experience of Japan. Finally, we look at the risks that the ECB would be exposing itself to. We do this in a Q&A format.
1. Would equity purchases be legal?
Although equities are not part of its collateral framework, and there will likely be legal challenges and controversy, there is no law against the ECB buying equities.
ECB officials have suggested it is an option
Comments from ECB officials suggest it is an option, with the main doubts relating to its effectiveness rather than its legality. Two of the most important comments were made by Chief Economist Praet back in October 2015 and by President Draghi at the Q&A session of the 2014 December Governing Council meeting. Reuters reported (see here) that when Mr Praet was asked whether the ECB would buy equities he cautioned that there might be little point in building a small position in a new asset class. Meanwhile, President Mario Draghi was asked which kind of options for asset purchases were discussed in the Governing Council (see here). He said that the inclusion of all assets was discussed, with the exception of gold.
Court rulings give ECB room to manoeuver
Meanwhile, the German constitutional court and European Court of Justice (ECJ) rulings on the OMT would comfort the ECB that any legal claims would bear little or no fruit. The German court decided that the OMT was permissible under German law. The decision therefore indirectly paved the way for the ECB to carry on with its QE purchases. Although the German court expressed concerns and gave six conditions, which the ECB must follow, we think that these would still allow equity purchases. The ECJ also ruled the OMT was legal, concluding that ‘the ECB must have a broad discretion when framing and implementing the EU’s monetary policy, and that courts must exercise a considerable degree of caution when reviewing the ECB’s activity, since they lack the expertise and experience which the ECB has in this area’.
Precedence from other central banks
In addition, there is a precedence of the policy being adopted by other central banks. The prime example is BoJ, but also other central banks like SNB, the Czech central bank and Hong Kong’s central bank have used this policy tool before.
2. How would the ECB buy equities?
BoJ’s ETF purchase structure could be used as blueprint
Since the ECB has never bought equities before, it lacks specific operational knowledge and experience in this area. We think that, as an example, the structure that the BoJ uses could work. The BoJ purchases equities by buying ETFs via a trust bank and a money trust, which track the Tokyo Stock Price Index (Topix), the Nikkei 225 Stock average or the JPX-Nikkei index 400.
Hiring an external manager is not new for the ECB as it appointed asset managers before for its ABS programme. As under the ABS programme, the ECB would continue to have full control over the purchases and will be able to give explicit instructions prior to approving the purchases. Furthermore, ETFs are known for their flexibility and they can be tailor-made to the central bank’s requirements. The inclusion of these assets will therefore increase flexibility for the ECB to target specific credit easing. For example, the BoJ tweaked its initial programme by buying ETFs that focus on domestic firms which proactively make investments in physical and human capital. More recently, the BoJ changed its purchase composition by skewing more buys to the market capitalised Topix index. The shift comes at the expense of the price weighted Nikkei 225. The ECB could use similar requirements and tweaks to ensure the breakdown in terms of the equity markets of the various member states that it regards desirable.
3. How big could an ECB ETF purchase programme be?
European ETF amounts to EUR 450 bn…
Here we can also use the BoJ experience as benchmark. The European ETF market currently amounts to around EUR 450bn, which is larger than the Japanese market (EUR 180bn) but much smaller than the US market (EUR 1.780trn), according to consultancy firm ETFGI. In comparison, the size of the European ETF market, roughly equals the size of the current eurozone regional bond market (EUR 400bn) and is somewhat smaller than the supranational market (500bn).
…but it could grow significantly
However, this is only a starting point as an ETF programme would lead the market to growing in size. The Japanese ETF market experienced strong growth following the stepping up of the BoJ’s ETF purchase targets. The Japanese ETF market experienced the strongest year-on-year growth in 2013, 2015 and 2016. For these years, the increase of ETF assets and the number of ETFs easily outpaced the Nikkei 225 index. The developments in 2016 are extraordinary as the Nikkei 225 index declined while ETF assets and the number of ETFs continued to grow. We think it is likely that the BoJ’s decision to buy additional ETFs in December 2015, which focus on investing in human and physical capital, has been supporting the growth of the Japanese ETF market.
Size of the programme could be around EUR 200bn…
The BoJ has increased and tweaked its ETF program on several occasions and is expected to buy at an annual rate of 6trn yen per year. The most recent data show that the BoJ owns about 60% of the total Japanese ETF market. It is difficult to know what impact an ECB ETF programme would have on the growth in the market. However, judging by the Japanese experience, a conservative assumption is that the market could grow by 30% on the announcement of a large scale ETF program by the ECB. This would mean that the market would increase from currently EUR 450bn to around EUR 600bn. Again taking a conservative approach, we estimate that the ECB would then be able to buy around 30% of the total size, which would equate to an ECB ETF programme of around EUR 200bn.
…which is small compare to overall QE programme
As a result, he ECB’s ETF programme could be much larger than our estimate of the corporate bond programme (EUR 75bn), roughly equal in size to our projection of the supranational purchases (EUR 175bn) but much smaller than our projection of the covered bond and ABS programme (EUR 300bn) let alone the government/national agency bond programme (EUR 1190bn).
This means that a potential ETF programme should firstly be regarded as an add-on instead of the new heart of the QE programme. However, the European ETF market could potentially grow much more rapidly than we assume, as was the case in Japan. So the risks to these estimates are to the upside. Still, it would not be large compared to the overall size of the QE programme.
4. Which countries would benefit?
ECB would move to market weighted approach and keep risk sharing regime
At the core of the rules of the current QE programme for government and national agency bonds, is the allotment of the QE purchases via the capital key and the regime in which national central banks are responsible for the risks arising from the purchases of their own national bonds. Although President Draghi recently said that the Governing Council has tasked the committees to explore the possibilities (including the capital key) for a smooth execution of the programme, we think that the ECB will be hesitant in changing these key concepts for the public sector purchase programme.
However, we note that the ECB has already moved away from the capital key for its corporate bond purchases, while it has also adopted risk sharing for this programme. Given the similar deviations of the equity and corporate bond market structures to the GDP weighted capital key approach, we would argue that the ECB would choose for a market weighted approach. In addition, we would argue that as in the case of the corporate bond programme, the ECB would adopt a risk sharing regime.
France, Holland and Germany would benefit, peripheral countries would lose
These choices would mean that certain countries could benefit from a market-weighted approach, assuming no additional tweaks, while others would be treated less favourably. The build-up of the iShares MSCI eurozone ETF index shows that France (32%), Germany (30%), the Netherlands (10%), Spain (10%) and Italy (7%) are the largest constituents. An analysis of the composition of the Stoxx Europe 600 index gives a similar ranking, when excluding non-eurozone members like the UK and Switzerland. An analysis on comparable ETFs issued by DB X-trackers and Vanguard gives broadly similar results.
When comparing the weights of the iShares MSCI eurozone ETF with the revised ECB capital key, France, the Netherlands, Germany and Belgium would benefit from a market-weighted approach. Peripheral countries would surprisingly benefit less as their capital key shares are larger than their weightings in the iShares MSCI eurozone ETF index.
5. Would an ECB ETF programme boost equity prices?
The experience of the BoJ’s ETF purchases, indicates that they did little to boost equity prices on a sustained basis in Japan.
On the surface, Japan’s NIKKEI index outperformed the MSCI world, the S&P 500 and the euro Stoxx indices between April 2014 and December 2015. This coincided with the stepping up of purchases in two steps in April and October 2014. The chart below shows the rise in ETF purchases roughly tracked Japanese equity outperformance during this period.
Equity gains following Japan’s ETF purchases probably reflect yen weakness
However, this is far from the whole story. First of all, Japanese equities have underperformed since December 2015 even though ETF purchases continued. Indeed, the recent further stepping up of purchases does not seem to have had much of an impact. So something else seems to have caused these swings. This brings us to the second point. The relative performance of Japanese equities seems to have been much more closely linked to movements in the yen over this period. The sharp fall in the yen spurred Japanese equities up to December 2015, and the subsequent rise in the yen led to their underperformance (see second chart).
Japan is not the only country where the authorities have ‘intervened’ in the equity market. Of course China’s recent experience of trying to prop up equities is also far from a success story. The bottom line is that there is a lot of uncertainty about whether ECB ETF purchases would have such a big impact on equity prices without going hand-in-hand with euro weakness.
6. Would equity purchases boost growth and inflation?
Most likely the effects on growth and inflation would be modest. QE works in five ways. First of all, it can boost the price of the assets purchased. Above we have expressed doubts about whether an ECB equity programme would have a major sustained impact on equity prices. But what if the ECB launched an ETF programme that did lead to a rise in equity prices of say 10% contrary to the evidence in Japan. Would that have a big impact on economic growth and therefore inflation? Here we are also doubtful.
Following the financial crisis, ECB economists looked at the impact on consumption from changes in household wealth. Their estimates of the change in consumption from a 10% rise in various types of wealth are shown in the table below.
Although the impact of a 10% rise in currency and deposits is very large (leading to a 2.4% rise in consumer spending in the long run) a similar rise in equities and mutual fund shares has a much smaller effect (0.3%). This would equate to an only 0.2% rise in GDP. One reason for the small effect is that eurozone households on aggregate tend to hold less equities relative to their income than those in other advanced economies. The impact on inflation would be similar to that on GDP at 0.1-0.2%.
A second way QE can work is through portfolio re-balancing effects. If the central bank buys safe assets such as government bonds, it can push investors out of these into riskier assets, boosting their price as well. These second round effects are unlikely in the case of equities as they are already at the far end of the risk spectrum in terms of eurozone assets. However, it could be that investors move outside of the eurozone, to for instance emerging market assets, which could push down the euro and therefore raise growth and inflation. Still, given the size of the programme and stickiness of mandates, the resulting fall in the euro would unlikely be large. This is especially the case in trade-weighted terms, given the eurozone’s trade is dominated by the US and other EU member states.
Third, credit easing. By increasing demand for equities, it may increase the availability of (in this case equity) finance for companies. These effects are probably modest given the current relatively favourable climate on equity markets. Fourth, QE puts liquidity into the banking system (as it buys assets and gives money to investors who eventually put it in the bank). It is hoped then that some of the liquidity in the banking system is lent out to households and companies. The ECB’s existing QE programmes have already reached EUR 1 trillion (and rising) so it is debatable whether an extra EUR 200bn would make a big difference in spurring liquidity and eventually bank lending.
Finally, there is a signalling effect. By buying equities, investors could change their perception of the ECB’s reaction function, and decide the central bank is willing to do whatever it takes. This in itself could raise inflation expectations, though it is difficult judge to what extent markets would be convinced, given some of the issues we have raised above.
7. What would be the risks associated with an ECB ETF programme?
The potential risks are relatively high. Although the ECB has recently increased the risk on its balance sheet by buying investment-grade corporate bonds, equity purchases are riskier still. The ECB does not have to worry about price swings with regard to investment-grade bonds because it is a buy-and-hold investor and therefore only needs to be concerned that the company will pay up when the bond matures. According to S&P, the cumulative default rate on investment grade debt is around 1%, which means that losses would be relatively limited.
On the other hand, the only way the ECB can get ETFs off its balance sheet is to sell them, so price swings matter. If equity prices were to fall sharply, there is no guarantee that they will recoup those gains over the time horizon that the ECB would like to sell. In addition, the Eurosystem’s accounting framework suggests that ETF holdings will need to be measured at end-of-period market value. That could mean that any price fall would show up relatively quickly.
Conclusion: ECB equity purchases seem unlikely in the near term
Overall, the ECB would be increasing the risk on its balance sheet for uncertain, and at best modest gains in economic growth and inflation. In addition, the ECB has other stimulus options (even though the effectiveness is diminishing). Furthermore, the current situation of moderate economic growth and relatively elevated equity valuations, also makes the case for ECB equity purchases weak.
In the near term, the ECB will likely extend its public sector purchases later this year, including taking measures to expand the universe of government bonds it can buy. We do not think launching an ETF programme is even a remote possibility.
Looking further ahead, if there were to be a large demand shock that led to a collapse in equity prices, that would make an a ETF purchase plan more likely. In the case that equity valuations were unusually depressed (as was the case following the financial crisis for instance) such a programme could also be more effective in boosting equity prices. However, even then, the cost-benefit analysis would likely make most members of the Governing Council cautious.
It’s coming closer to election time, and it’s hard to shake the feeling that something crazy or unprecedented could happen in the coming months.
Trump and Clinton are the most disliked presidential candidates in history, both having an “unfavorable” image with the majority of the U.S. population. Meanwhile, according to a recent Pew Research poll, only 24% of registered voters feel that the next generation of Americans will be better off than folks today.
PICKING UP STEAM
But, as Visual Capitalist's Jeff Desjardins notes, for the first time in almost 20 years, the third-party candidates are getting attention across the board. Gary Johnson (Libertarian) and Jill Stein (Green) are even getting regular mainstream coverage from outlets such asCNN, Vox, The Washington Post, The NY Times, Forbes, and The Wall Street Journal.
The poll numbers for Johnson and Stein are respectable, especially among the millennial crowd where they garner around 40% of voter support. When it comes to the general electorate, however, average poll numbers are more muted with Johnson averaging 9% and Stein 3%.
The numbers are not enough to meet the arbitrary 15% threshold for the first round of debates, but the third-party candidates are starting to pick up steam in other areas. For example, Gary Johnson just shattered a fundraising record for the Libertarian Party by raising $5 million in August. Meanwhile, Stein is preparing for a major publicity stunt at Hofstra University in New York – the site of the first Presidential Debate on September 26th.Courtesy of: Visual Capitalist
AN END TO THE TWO-PARTY DUOPOLY?
Regardless of how Johnson and Stein fare, this year could symbolize a resurgence for third-party candidates in the national conversation. After all, it seems that growing discontent with the two-party duopoly can be found in a variety of places.
More people are now aware that the committee that set the arbitrary debate threshold of 15% was established jointly by RNC and DNC officials. This makes it almost impossible to get a third-party candidate onto the debate stage. However, if you ask actual voters about the third-party candidates, the answer is clear: 52% of Americans want to see Gary Johnson in the debates, while 47% would like to have Jill Stein’s voice heard.
Further, supporters of Bernie Sanders found out first-hand that the elections are not as democratic as they once seemed. Leaked emails from the DNC showed that the party worked against Sanders to ensure a Clinton nomination. Sanders supporters also found out the true power of superdelegates, which were initially created by the DNC elites to ensure their choices were considered disproportionately.
Lastly, it’s also worth noting that the media landscape has changed. There is no longer a few television networks that dominate the conversation, and people now have more access to independent media than ever before. This fragmentation increases competition and gives outsiders the opportunity to express opinions – it also allows groups like Wikileaks to do their thing by uncovering scandals or other unfair play. The new generation of media will lead to the exploration of different alternatives in both opinion and policy. With that will come more support for third-party candidates that align themselves with those viewpoints.
Some people will consider a vote for a third-party candidate as a waste, and others will condemn it as a mere “protest” vote. Likely, some people will also consider Johnson and Stein as the candidates that best reflect their values, and they’ll consider the “lesser of two evils” argument to be one without merit.
Regardless of what happens, for better or worse, the Libertarians and Greens will likely leave their stamp on this election. Hopefully it’s one that ends up being a net positive for the future.
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