Rabobank: The Same Central-Bank Trends Are Emerging Everywhere

By Michael Every of Rabobank

PM Draghi-CB

It is for once a relatively uneventful day, by recent standards – apart from the UK and the EU potentially reopening the wound of the Brexit trade deal re: Northern Ireland after the EU’s recent ham-fisted decision to nearly impose a hard border between it and Ireland in order to keep precious vaccines inside its territory – watch this space. That such a deal is already under pressure just weeks into its existence does not bode well: and we know the stark binary that sits on either side of failing to stick to it. Perhaps for that reason, markets are calm – “because markets”. Additionally, for once there are no headlines about the imminent collapse of Western liberal democracy, or of the global order.

Prospective PM ‘Draghi-CB’ in Italy, the other big headline, was covered here yesterday, and the market adulation is as lavish as had been expected. On which note, allow me to share the latest fruits of our Euro team’s labours, focused on said central bank (click here). They look ahead to the “Roaring” 20s, and like myself, are including plenty of room for that roaring to not include the clink of champagne or gin glasses in good-time speakeasies, but of angry crowds wondering where growth and inflation went.

They summarise that the Covid pandemic has not only further increased markets’ reliance on the ECB, but also depleted more of its policy tools, which raises a number of challenges: either in terms of finding new ways to prop up growth and inflation or (eventually) tightening policy without sparking the next crisis.

They have three scenarios for the economic outlook and the resultant development of ECB policy in the years ahead: first is a Japan-like ‘lowflation’ scenario (“The songs of angry men” style roaring); the second is a more moderate ‘gradual recovery’; and the third is a Flapper-happy “Roaring” reflation. (Which is what the market still takes as what is going to happen for sure, without doing any of the joined up thinking of (i) why now; and (ii) what will happen if it does -“because markets”.)

They argue that in all three scenarios, yield curve control will play an important role in policy going forward, but it takes on very different shapes and objectives. Specifically, if further easing is required (assuming the Japan scenario), traditional YCC with outright yield targets will probably be the next stop.

Secondly, they play with the idea of an NPLTRO –try saying that after a swig of bootleg gin– which mixes the necessary support for risks related to non-performing loans (the NPL part) with cheap funding (the LTRO part). This is likely more effective than a TLTRO-IV –try saying that after a swig of bootleg gin too– considering that recent tightening of credit standards is mainly due to increased risk perception.

In the case of policy tightening, they argue that YCC will instead be focused on spread control. In a moderate scenario, the ECB could simply leave the envelope on the table as a backstop, even after net purchases are reduced to zero. In more severe cases, the ECB could consider sterilised asset purchases, to ensure that the draining of liquidity does not excessively widen spreads.

Should it ever have to do, in order to drain liquidity, the ECB will probably issue ECB bonds or auction fixed-term deposits, rather than selling the assets in the APP/PEPP portfolio. This limits the potential spread widening impact, allowing the ECB to drain liquidity more quickly. 

The ECB report is well worth a read. But in short, things are going to get far more technocratic and complicated, or to put it another way, a yield curve that is as (indirectly) political as PM Draghi-CB himself now is.

Moreover, if you think that this applies to just the ECB, think again. Yes, it is a particularly complex beast given its nature, and by being the only truly viable, global EU institution: but the same central-bank trends are going to emerge elsewhere.

I don’t just mean the PBOC, which has apparently just struck a deal with Ant Financial that will put all of the latter’s businesses into a holding company, including its technology in areas such as blockchain and food delivery. Ant won’t have to be spun off, but looks as if they will be tightly regulated on all key fronts instead. I also don’t just mean the RBI, which is flagging it will ban cryptocurrencies and proceed to develop its own national version for India, a trend others including China may well follow very soon. (Don’t be shocked, ‘cryptonites’. Recall what happened to gold in the 1930s the last time we needed global reflation: it got confiscated by the Fed.)

Indeed, allow me to go further:

If we get the wrong kind of “Roaring” 20s, then the line between government and central-banks put in place back in the 1980s is going to (gradually?) be erased; but

If we get the right kind of “Roaring” 20s, that is also going to happen because we will have built up such an addiction to debt and low interest rates.

Does one begin to see why independent central banking has been only a blip in mankind’s historical numismatic experience, as we endlessly argue over what is and isn’t money, and who does and doesn’t get access to it? Something to ponder, along with that ECB report, on a relatively quiet day in a week in which silver has been on people’s minds.