The one theory I know of that seems to do a decent job of explaining Japan -- at least, in a rough, basic sort of way -- is Neo-Fisherism, the radical monetary theory being promoted by economists John Cochrane and Stephen Williamson. This idea holds that low interest rates, if they continue long enough, cause inflation to fall rather than rise. Japan’s recent experience matches this. Neo-Fisherism has so far been rejected by many mainstream theorists, but Japan could provide support for Cochrane and Williamson’s rebellion.
Mario Draghi’s plans to buy corporate bonds will cut financing costs for European companies, if history is any guide. Getting the firms to actually borrow and spend money will be harder.
Corporations already have hefty incentives to sell debt, with average yields on investment-grade bonds in the region below 2 percent for a second year. But they have little appetite to raise money to invest in new factories and equipment, as the outlook for the global economy dims.
Euro-area consumer spending growth slowed to 0.2 percent in the fourth quarter from 0.5 percent in the third. While investment picked up in the quarter, total economic growth was still limited to just 0.3 percent. Confidence among households dropped in February to its lowest level in more than a year.
“If you don’t need the funds then why should you raise them?” said Ivo Kok, the treasurer of Alliander NV, an investment-grade Dutch gas and electricity distribution company. “It is more of a risk to have an awful lot of cash around that you’re not putting to work.”
The European Central Bank said on Thursday that it will start buying investment-grade corporate bonds sometime toward the end of the second quarter, as part of a broader bond purchase program. To help stave off deflation and stimulate growth, it plans to buy 80 billion euros ($89.46 billion) of debt a month, also including euro zone government bonds, asset-backed securities, and covered notes.
The central bank is also taking steps to provide cheap funding to banks through a program known as “targeted longer-term refinancing operations.” That financing, which essentially pays banks to borrow, is meant to encourage more lending.
But even before the ECB’s moves, companies had access to cheap credit, said Gary Herbert, a fund manager at Brandywine Global Investment Management LLC, which oversees about $57 billion in global fixed-income assets.
“Is there a need to lever up a balance sheet to grow a business when underlying customers aren’t demanding more of what you make?” Herbert said.
Overseas companies may decide to borrow more in Europe just to take advantage of low rates, and because the U.S. Federal Reserve started raising short-term rates in December. U.S. companies alone, from Apple Inc. to McDonald’s Corp., sold more than 87 billion euros of corporate bonds in the single currency last year.
The ECB is buying investment-grade debt, but as it helps push yields on those securities even lower, some investors will likely buy more higher-yielding junk bonds....
The speculative-grade market in Europe is in need of a boost, with sales down 76 percent in the slowest start to the year since 2011, according to data compiled by Bloomberg. Only three sales larger than 500 million euros were completed in 2016, with Telecom Italia SpA and ThyssenKrupp AG each selling 750 million euros of bonds and Lincoln Finance Ltd. raising 1.25 billion euros of bonds on Thursday to fund the buyout of LeasePlan Corp, a Dutch vehicle-leasing company
The euro-area’s corporate bond market has ballooned to 900 billion-euros up from 500 billion euros of outstanding securities 10 years ago, according to data compiled by the ECB. That gives Draghi plenty of scope to boost its QE hoard, so long as the program for buying the debt is well-designed....
The ECB’s purchases have so distorted the 250-year-old covered bond market that the first covered notes priced with a negative yield were sold this week. Meanwhile, in the secondary market, almost 70 percent of German covered bonds have yields of less than zero, according to HSBC Holdings Plc.
“It has become a political player. It is using unconventional monetary policy to engage in economic and fiscal policy,” he said.
Mr Draghi brushed aside the criticisms, insisting that the eurozone would have faced “disastrous deflation” and a spiraling rise in debt ratios if the ECB had not taken drastic action over the past two years...
Mr Ostwald said the ECB package is akin to the US bank rescue schemes after the Lehman crisis (TARP & TALF), and amounts to a belated admission that the European banking system is still in dire straits. Non-performing loans in Italy have reached 17pc.
“Everything that the ECB has just done is about balance sheet resolution for banks after dodging the problem for years with extend and pretend,” he said.....
Hans Redeker, currency chief at Morgan Stanley, said foreign exchange traders had latched onto a subtle shift in ECB policy. It is moving away from efforts to force down the yield curve on sovereign debt, switching instead to a drive for lower corporate credit spreads. This is likely to draw money into eurozone assets.
Negative interest rates are widely seen as a tool to force down the exchange rate, a form of “currency war” that will no longer be tolerated by the US after the G20 meeting in Shanghai. The ECB’s shift to other tools is a sign that it is backing away from this game. “We’re not in that war at all,” said Mr Draghi.
It dished out rate cuts, taking its main rate to zero and its deposit rate to minus 0.4%. The ECB also increased its asset-purchase program to €80 billion ($88 billion) a month and added corporate bonds to its shopping list, meaning it is involved in a vast swath of Europe’s fixed-income markets. And it is launching a new series of tenders offering ultracheap long-term financing for banks, the last of which will mature in 2021, 14 years after the global financial crisis broke out......
But these programs may not be a silver bullet for Europe’s woes. ECB purchases of eurozone-issued corporate bonds may encourage more issuance in euros by U.S. corporates, who have eagerly sold bonds in Europe to fund shareholder-friendly measures like stock buybacks. Some market participants fear that the ECB might exacerbate liquidity problems in corporate bonds. Meanwhile, the ECB’s new targeted lending programs, while more attractive, will depend on the appetite of banks to lend and eurozone companies to borrow.
Time to switch focus. Until now, the euro’s exchange rate has been closely tracked as an indicator of the effectiveness of the European Central Bank’s stimulus programs. Now eurozone corporate bonds are the crucial barometer investors need to watch.
Thursday’s decision to add corporate bonds to the ECB’s purchase programs marks a shift in President Mario Draghi’s strategy. Previously, much of the focus was on lowering the government-bond yield curve, which had the side effect of delivering a weaker euro both to help growth via exports but also boost inflation via higher import prices. Now credit markets have joined the party, which means corporate bond spreads—the gap between yields on company debt and underlying government bonds—are of vital importance.
There are pitfalls too. The success of the program will ultimately depend on companies’ appetite for investment. And the ECB’s largess in lowering the overall cost of borrowing in Europe has led to a rush of euro-denominated bond issuance by U.S. companies. Last year, they accounted for nearly a quarter of issuance and so far this year for a third, Société GénéraleSCGLY4.33% notes. Some of the ECB’s efforts may just contribute to more debt building up on U.S. investment-grade balance sheets.
The spread on BAML’s European corporate bond index has already narrowed to 1.43 percentage points from a February peak of 1.63 points. The cost of insuring European company debt against default has fallen very sharply since the ECB decision was announced; cash bonds are slower to move, but there is substantial room for a rally from here. How far it goes, and how much it stirs the animal spirits of company executives, will determine how effective the ECB’s latest gambit proves to be
Conditions for financing are extremely attractive, given the European Central Bank’s ultra-loose monetary policy. While credit spreads are wider than precrisis, yields are at historically low levels. Investors are willing to buy long-dated bonds like never before.
But it is U.S. companies that are taking advantage of this appetite: as of May 22, the U.S. was the single-largest source of bond sales this year, accounting for 28% of investment-grade issuance, versus 17% in the whole of 2014, according to Société Générale.SCGLY4.33% In the past two weeks, restaurant chain McDonald’s,MCD1.31% conglomerate United TechnologiesUTX0.59% and pharmaceutical company Eli LillyLLY2.23% have all issued euro bonds. U.S. companies now account for 15% of the issues in Barclays’ euro corporate index, versus 7.5% precrisis, and a string of firms have made their debut in euros. They have even been turning to the European high-yield market, a striking development...
But it does appear that European companies are still cautious: the European Central Bank says high levels of financial risk-taking aren't being matched by economic risk-taking in investment and lending.
Credit markets soar after European Central Bank said it will begin buying corporate debt ...
some investors had doubted the ECB would buy high-grade corporate bonds given that companies can already borrow cheaply. The average yield on investment-grade eurozone corporate debt was 1.3% on Wednesday, according to Barclays.BCS4.43% ...
The ECB buying corporate bonds is “very significant,” said Marilyn Watson, a senior bond strategist at BlackRock Inc.BLK4.51% “Everyone is trying to assess the impact on financials and nonfinancial corporates.”...
Among the benefits, the ECB’s buying could encourage an increase in new debt sales from eurozone companies, said Mitch Reznick, co-head of credit at Hermes Investment Management.
Strategists at Citigroup Inc.C3.92% estimate there is about €500 billion in corporate debt that the ECB could buy. Analysts at J.P. Morgan ChaseJPM1.25% & Co have estimated the ECB could buy €12 billion of corporate bonds a month without distorting primary and secondary markets....
Buying high-grade debt will push down yields on these bonds and that should encourage investors to shift into riskier bonds. That means the benefits of the program should trickle down to the junk-bond market, according to strategists at Citigroup Inc
Bank stocks rose sharply as the implications of the ECB’s policy moves became clear
Mario Draghi is worried about eurozone bank profits after all....
Negative rates are a nightmare for banks: they have to pay to leave money on deposit at the central bank and can end up paying to own government bonds. At the same time, banks can’t pass negative rates to retail depositors either because they fear the money will leave, or in some countries because they aren’t allowed to by law.....
To protect banks and stop them cutting back lending, the ECB launched more targeted lending operations, known as TLTRO II. These offer banks more than €700 billion of fresh four-year funding, according to Barclays,BCS4.43% to back their loans to companies and consumers, but not mortgages.
At most this will cost banks nothing. But if they have grown lending by 2.5% by the end of January 2018, the interest rate they pay could drop to the ECB’s deposit rate at the time the funding was taken. That was cut to minus 0.4% on Thursday....
This funding is a cheap option to replace banks’ maturing bonds with more than €500 billion due for repayment in the next two years, according to Standard & Poor’s, as well to refinance existing ECB money. The lower costs would add a net €3 billion, or up to 2.5%, to annual earnings, according to Deutsche Bank....
These moves are having the desired effect in the markets: two indices that measure the riskiness of senior and subordinated European bank bonds dropped sharply.
The ECB said on Thursday that it will start buying the investment-grade, euro-denominated debt of nonfinancial eurozone companies toward the end of the first half of the year. It has ruled out buying bank debt.
ECB President Mario Draghi said buying corporate bonds would help further ease financing conditions in the eurozone economy. That could make it cheaper for companies to borrow money to invest.
Corporate bonds will be included in the ECB’s broader asset purchase program, which mainly focuses on government debt and, on Thursday, was expanded from €60 billion to €80 billion a month.
The program is almost without precedent....
Investors expect the ECB’s program to be different. Companies issued €324 billion ($350 billion) in euro-denominated corporate bonds last year.
Their concern, though, is that the ECB may become too big a player in the euro credit market and end up fueling a credit bubble.
Nicolas Trindade, a portfolio manager at Axa Investment Managers, said that the ECB program could encourage investors to buy bonds just on the assumption their prices will keep rising, without paying attention to the creditworthiness of individual companies.
Investors also worry that the ECB could end up holding large portions of the market and harm liquidity, meaning it is harder for others to buy and sell debt without unduly moving prices....
High-yield debt markets also rallied, and protection against a default on bank debt fell back to levels last seen in early January.
With the majority of fourth-quarter results in, earnings per share declined 4.3 percent for their deepest growth decline in the S&P 500 since 2009, according to S&P Global Market Intelligence. Lack of earnings growth and concerns about the effectiveness of monetary policy amid signs of a slowing global economy rattled stocks at the start of this year. All three major averages fell into correction territory, or more than 10 percent below their 52-week intraday highs.
"To me we just saw a bear market rally over the past month," said Peter Boockvar, chief market analyst at The Lindsey Group. "Very likely the Fed and Bank of Japan next week caps the end of that bear market rally. Central banks are really the most important thing in terms of their influence."
"Market multiples will go down as people lose faith in central bank influence," he said. "People should see central banks are out of bullets in terms of their influence. You put that on top of earnings growth that is slowing already."
With debt prices set to tumble as the ECB buys what it can, it makes sense for European companies to raise debt at close-to-zero interest rates and use the proceeds to buy back their stocks or pay higher dividends, suggests Bill Blain, strategist at Mint Partners. “Perhaps it’s time to buy the shares of European investment-grade corporates,” he says.
Measures that artificially boost equity markets but add little or no net value to the real economy should be rethought.
In essence, the cut in rates is aimed at further lowering borrowing costs (monetary conditions), and the addition of corporate bonds to the asset purchase programme will increase the stock of eligible assets and also reduce credit spreads (credit conditions).
The new TLTRO programme goes even further by applying rates as low as the deposit facility (minus 0.40%) for loans of four year maturity, effectively paying banks to borrow money they will subsequently lend. ...
It is open to debate whether the ECB has refocused its attentions away from lower rates – and therefore targeting a lower euro – and towards cajoling banks to lend through de facto taxes or incentives. However, in our view such coaxing does not address the more pertinent issue, which is that capex and business investment remain in the doldrums and, as has been equally visible in the US and Japan, corporate borrowings (or cash piles) have predominantly been put to use in share buybacks to boost share prices.
While this may benefit shareholders and certainly CEO’s, the benefit to the real economy or indeed the efficacy of the attempt to “reinforce the momentum of the euro area’s economic recovery and accelerate the return of inflation”, to use Draghi's formulation, is likely minimal at best....
Furthermore, while the debate over the best transmission mechanism for monetary stimulus at the lower bound is complex, one thing is clear: The measures introduced by the ECB yesterday have, in the near term at least, led to a tightening of monetary conditions and a sharp uptick in the level of volatility, neither of which would have been hoped for.
Plus ça change, plus c’est la même chose
Ultimately, despite the sharp correction higher in the EUR yesterday, our macro view remains little changed. Europe is the only continent without any significant growth since 2008, but we would argue that the ECB’s policy response is excessive in relation to the slow but by no means collapsing growth backdrop in the Eurozone.