By how much has the ECB artificially inflated Irish bond prices?

An econometric analysis of Eurozone sovereign bond spreads relative to Germany was published today.

http://cib.natixis.com/flushdoc.aspx?id=85443

The analysis charts sovereign risk premia (1999-2012) in light of the countries' fiscal deficits, public debt, and external deficits over that time series.

In doing so, it attempts to set predictions of how those spreads should look today, compared to how the spreads have actually turned out.

The gap between expectations and actual spreads was smallest in fiscally prudent countries like Austria and Finland. However, the exercise finds that we should expect Ireland to have a spread of 470 basis points (that's 4.7%) higher than the actual. This was the highest gap between 'estimate' and 'actual' in the Eurozone, along with Portugal.

How can we explain this anomaly? ECB intervention is the most obvious explanation.

So is all of this self-congratulations regarding the Irish benchmark bond quite overblown? Almost 5% overblown?

glacial_pace71

QE will certainly be a distorting factor. However, generally bond prices globally are quite ridiculous but there's so much credit out there beyond the ECB that's chasing safe havens ...
Of course, another distorting factor in those stats is that the Irish GDP figures are still a figure of fun, e.g. the recent Big Pharma patent cliff saw some plunges in notional exports etc when it was mainly an unwinding of transfer pricing plays anyway, e.g. the underlying jobs in Ireland are real enough, as are their wages, but the taking of a small cut by the Irish Govt of money being laundered through Irish GDP figures is coming to an end.
There are too many unique factors in the Irish story to say that Irish bonds are any more outlandishly priced that several other countries, inside and outside the eurozone.

Sand

A Tyrant Named Miltiades! wrote: »

How can we explain this anomaly? ECB intervention is the most obvious explanation.

So is all of this self-congratulations regarding the Irish benchmark bond quite overblown? Almost 5% overblown?

Irish politicians and the green jersey brigade are notoriously quick to claim credit and deny responsibility. And everybody wants a good news story. The ECB have clearly been pumping so much money into the Eurozone economy (It makes a mockery of the earnest concerns over ELA a few years ago) that the banks have to spend it on something.

That said, easy and cheap credit is a boon to the Irish position - so long as its used to ease our crippling debt situation. Instead, Labour and Fine Gael seem intent on using it to repeat the mistakes of the 2007 election.

ardmacha

Sand wrote: »

That said, easy and cheap credit is a boon to the Irish position - so long as its used to ease our crippling debt situation. Instead, Labour and Fine Gael seem intent on using it to repeat the mistakes of the 2007 election.

As do every other party, sadly.

Sand

Sand wrote: »

That said, easy and cheap credit is a boon to the Irish position - so long as its used to ease our crippling debt situation. Instead, Labour and Fine Gael seem intent on using it to repeat the mistakes of the 2007 election.

Yes, and I've no doubt that the study will be dismissed by government supporters as a moot point, after all: from a financial viewpoint, it's the yield-spread that gets churned into the machine, not necessarily its causal factors. Who cares about jiggery pokery?

That's a fair response. But it raises another question: why did it matter so much during the ECB's conservative years, 2008-2012, when ECB intervention was apparently preposterous, imprudent and impossible?

We must be prudent, they said. We must pay. The ECB cannot press that button.

glacial_pace71

glacial_pace71 wrote: »

There are too many unique factors in the Irish story to say that Irish bonds are any more outlandishly priced that several other countries, inside and outside the eurozone.

The exercise seems not only consistent (big gaps in peripheral spreads, scarce gaps in spreads of fiscally prudent countries), but also entirely logical and expected.

Of course OMT and QE will have disproportionately benefitted the peripheral countries. This exercise merely attempts to put a number on the benefit.

generally bond prices globally are quite ridiculous

Theyre's nothing ridiculous about them. Up until recent weeks, they've been entirely consistent and in-keeping with what we would expect from 'whatever it takes' monetary policy.

frankbrett

I wouldn't attribute the narrowing of spreads to OMT and (actual) QE, rather a post-Draghi June 2012 perceived convergence of credit risk. The low yields in core eurozone markets drove a hunt for yield with peripherals deemed attractive given the commitment to do 'whatever it takes' to avoid another Euro crisis; this overriding economic fundamentals.

Where economic fundamentals have come into play is Ireland's decoupling from the PIGS and trading in line with semi core in the past year or so.

As was the case in the UK and the U.S., anticipated QE had a more pronounced effect on yields than actual QE. The recent volatility (begets volatility) has seen general curve shifts and steepening and may shift the balance back towards fundamentals as market sources believe traders over egged the hunt for yield and are now trying to rebalance portfolios.

frankbrett

frankbrett wrote: »

I wouldn't attribute the narrowing of spreads to OMT and (actual) QE, rather a post-Draghi June 2012 perceived convergence of credit risk. The low yields in core eurozone markets drove a hunt for yield with peripherals deemed attractive given the commitment to do 'whatever it takes' to avoid another Euro crisis; this overriding economic fundamentals.

But intervention is not simply commencing an action, in this case it is also announcing the commencement of the action, or 'whatever it takes'.

What I mean by ECB activity artifically inflating Irish bond prices is not just the ECB's own operations, but the anncouncement of their own operations in advance, knowing full-well the effect this would have on prices.

After all, the story here is not the cost to the ECB. The story is whether Irish bond prices can be attributed mainly to domestic reform or ECB intervention in all its forms.

frankbrett

A Tyrant Named Miltiades! wrote: »

But intervention is not simply commencing an action, in this case it is also announcing the commencement of the action, or 'whatever it takes'.

What I mean by ECB activity artifically inflating Irish bond prices is not just the ECB's own operations, but the anncouncement of their own operations in advance, knowing full-well the effect this would have on prices.

After all, the story here is not the cost to the ECB. The story is whether Irish bond prices can be attributed mainly to domestic reform or ECB intervention in all its forms.

True. My point being that the overall downward shift in yields across the Eurozone can be attributed to the ECB but Ireland's move from peripheral to 'semi core' can in part be attributed to Ireland specific indicators, such as growth/employment statistics and improved debt service profile as well as possibly a nod to contingent asset/liabilities such as the greater book value of bank holdings and CBI profits, although the latter is also boosted by ECB policy

Yes in part, after all, the Natixis exercise suggests benchmark Irish yields would be "only" around 7-8% if it were purely a question of the fiscal metrics.

So clearly, that's lower than the 12% or so we saw in 2011, and we have to factor in domestic policies as well, of course, as the wider European political landscape.

It is impossible to put a figure on the contribution made by domestic policies or EU/EA developments, but the ECB's contribution seems substantial.

This isn't so much about knocking the Irish Government as it is about asking why, if this was so easy, didn't it happen earlier?

Scofflaw

A Tyrant Named Miltiades! wrote: »

Yes, and I've no doubt that the study will be dismissed by government supporters as a moot point, after all: from a financial viewpoint, it's the yield-spread that gets churned into the machine, not necessarily its causal factors. Who cares about jiggery pokery?

That's a fair response. But it raises another question: why did it matter so much during the ECB's conservative years, 2008-2012, when ECB intervention was apparently preposterous, imprudent and impossible?

We must be prudent, they said. We must pay. The ECB cannot press that button.

Trichet versus Draghi, basically. The former took a very narrow view of the responsibilities of the ECB, the latter takes an expansive one.

cordially,
Scofflaw

Sand

Scofflaw wrote: »

Trichet versus Draghi, basically. The former took a very narrow view of the responsibilities of the ECB, the latter takes an expansive one.

cordially,
Scofflaw

I don't know - Trichet had some pretty alarming views on the ECBs remit. Draghis ECB is a lot quieter than Trichets.

I think its better said that Trichet refused to use the tools available to him to relieve the crisis (for political reasons imo), whereas Draghi has used every tool available to him to ease the crisis if not end it.

Demanding that financial stability for the banking industry in Ireland is "contingent" upon the implementation of specified governance policies by democratically mandated government of Ireland is not a narrow view of a Central Bank's remit.

I assume most people agree the Irish government had no option but to implement expenditure cuts, so to an extent, the Trichet ultimatum is moot.

Nevertheless it is important in that it suggests that Trichet took a broad view of his remit, and not the traditional, conservative view that has been suggested.

The US Fed was purchasing government assets as soon as the crisis struck in 2008. The UK began QE three months later. The ECB waited until 2012 to begin OMT and until 2015 to undertake QE proper; the latter has been an extraordinary relief for government debt burdens.

Imagine if this had started in 2008, accompanied by necessary expenditure cuts?

Would the banks ever have been bailed out? Would Ireland and other peripherals (bar Greece) ever have entered a bailout? Would the Irish bailout have been the cheapest bailout in history?

View

Scofflaw wrote: »

Trichet versus Draghi, basically. The former took a very narrow view of the responsibilities of the ECB, the latter takes an expansive one.

cordially,
Scofflaw

Both Trichet and Draghi were/are one person on a twenty+ person council. It is clearly wrong to say it is a matter of individual x or y being a critical factor since the most a person can bring in a council situation is a difference in communication style.

View

It should be pointed out that the remit of the ECB is to ensure price stability (via low inflation). It is not there to pump up the economy by printing money as other central banks do. Growth is left to the member states to achieve by their individual fiscal and de/regulatory actions.

The reason that the ECB is now engaging in some QE is to stave off a deflationary threat largely caused by falling oil prices. That wasn't the case a few years back hence the question of QE did not arise.

View

View wrote: »

The reason that the ECB is now engaging in some QE is to stave off a deflationary threat largely caused by falling oil prices. That wasn't the case a few years back hence the question of QE did not arise.

There's much more to it than commodities, which are projected to recover significantly later this year anyway. And whilst inflation will remain low, it will also remain positive and stable in the absence of QE, as indicated by forecasts and five-year inflation swaps prior to the QE announcement.

There is almost unanimous agreement that the deflationary threat has dissipated, if it even existed in the first place.

Moreover, extraordinary asset purchases via QE are an unlikely, or an unwieldy, way of staving-off deflation in the Eurozone. But it is good for asset prices, exports and economic growth in parts of the eurozone.

There is something really innocent about the idea that QE has nothing to do with reviving Eurozone growth. In reality, growth is on the floor, and the expansionary budgetary approaches are no longer available to give the zone a shot in the arm

andrew

A Tyrant Named Miltiades! wrote: »

There is almost unanimous agreement that the deflationary threat has dissipated, if it even existed in the first place.

There is? I was under the impression that the threat very must existed in the first place, look at the trend after 2012.

Moreover, extraordinary asset purchases via QE are an unlikely, or an unwieldy, way of staving-off deflation in the Eurozone. But it is good for asset prices, exports and economic growth in parts of the eurozone.

If it's good for economic growth (including exports) doesn't this imply that it's also 'good' for inflation?

andrew

andrew wrote: »

There is? I was under the impression that the threat very must existed in the first place, look

The "if it even existed in the first place" is my own skepticism, or rather, that of analysts far smarter than me.

The near-unanimity I refer to, is to the acknowledged dissipation of the so-called threat of deflation.
At worst, there is expected to be a blip in June, and stable, low inflation thereafter, accompanied by the rebound in oil prices. Sounds like price stability to me.

It is not credible to suggest that prices are so unstable as to justify QE until Q4 2016, which is the planned end-date.

In fact, you could reasonably speculate that QE might create instability through rapidly rising risky-asset prices, or because extremely narrow coupons on sovereign bonds make it impossible to raise interest rates without provoking another financial crisis.

So this doesn't really make sense from a price stability viewpoint.

I think the ECB is playing a game of chance here.

If it's good for economic growth (including exports) doesn't this imply that it's also 'good' for inflation?

I qualified that by saying 'in some parts of the Eurozone'. QE is good for Italy and Holland, for example.

It is good for asset prices across the zone, of course, but that doesn't mean it's good for inflation (for a classic example, look at Japan)

andrew

A Tyrant Named Miltiades! wrote: »

The "if it even existed in the first place" is my own skepticism, or rather, that of analysts far smarter than me.

The near-unanimity I refer to, is to the acknowledged dissipation of the so-called threat of deflation.
At worst, there is expected to be a blip in June, and stable, low inflation thereafter, accompanied by the rebound in oil prices. Sounds like price stability to me.

It is not credible to suggest that prices are so unstable as to justify QE until Q4 2016, which is the planned end-date.

In fact, you could reasonably speculate that QE might create instability through rapidly rising risky-asset prices, or because extremely narrow coupons on sovereign bonds make it impossible to raise interest rates without provoking another financial crisis.

So this doesn't really make sense from a price stability viewpoint.

I think the ECB is playing a game of chance here.

The ECB's Mandate is "Price stability, defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term "

I don't know which analysts referring to, but inflation was objectively not at or close to 2%, and so deflation was a threat. Also, seeing as monetary policy usually takes several quarters to work it's way through the economy, I'm not sure it's unanimous that the threat of deflation has disappeared. To the extent that there is agreement that is has, that conclusion is based upon continuation of QE until 2016 anyway.

Also, you're right that low interest rates are a threat to financial stability, in terms of asset prices and low yields, but financial stability isn't in the ECB's mandate, that's the European Systemic Risk Board's job (which AFAIK has delegated this to relevant 'national competent authorities', which in the Irish case is the CBI).

andrew

andrew wrote: »

The ECB's Mandate is "Price stability, defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.

The ECB's mandate, as laid out in treaty, is price stability.

The 2% figure is the ECB's own creation; it can be amended at any time by the ECB.

So "price stability" does not inherently mean inflation just below 2%, especially when low (but positive) inflation was attributed to demand-stimulating factors like low oil prices, and consciously undertaken wage restraint.

Q. Why do we hate deflation?
A. We hate deflation because it typically erodes asset prices and demand. But falling oil prices had the exact opposite effect, and asset prices were not being diminished! The masses were being pragmatic about the source of low inflation/ 'threat of deflation'. The ECB's dramatic intervention didn't make sense.

you're right that low interest rates are a threat to financial stability, in terms of asset prices and low yields, but financial stability isn't in the ECB's mandate

But the crisis would stem from diminishing asset prices! The latter problem is one of the core threats to price stability, and one of the reasons deflation is so dangerous. This is an obvious, clear connection between financial crises and price stability.

All I'm saying is that what the ECB has done is risky. When you assess the situation critically, it is clear the ECB cannot credibly claim to have taken that risk because of price stability, although headline inflation rates do provide a convenient cloak.

Just to add I am not knocking QE per se.

It worked a treat elsewhere, and I was whingeing like a whipped pup when they weren't doing it back in 2009. But the official justification for commencing it now is weak, and it's probably three years too late.

View

A Tyrant Named Miltiades! wrote: »

There's much more to it than commodities, which are projected to recover significantly later this year anyway.

I said "largely" not solely.

A Tyrant Named Miltiades! wrote: »

There is almost unanimous agreement that the deflationary threat has dissipated, if it even existed in the first place.

Given that Eurozone inflation was +0.3% in May, 0.0% in April and negative before that this year it is hard to see any basis for complacency on it.

Indeed were there "unanimous agreement" that it had, the ECB would be looking at terminating QE as it would be unnecessary.

A Tyrant Named Miltiades! wrote: »

There is something really innocent about the idea that QE has nothing to do with reviving Eurozone growth.

Well it is an innocent view shared by the ECB since "reviving Eurozone growth" is not a reason they have stated is an aim of their program.

Were it their aim they'd need to be aiming for a much larger package and to intend to keep it running for longer until, let's say, growth (and inflation) were at 3%+ - no one expects them to do that and that'd probably face legal challenges were they to attempt it.

Sand

View wrote: »

Given that Eurozone inflation was +0.3% in May, 0.0% in April and negative before that this year it is hard to see any basis for complacency on it.

Indeed were there "unanimous agreement" that it had, the ECB would be looking at terminating QE as it would be unnecessary.



Well it is an innocent view shared by the ECB since "reviving Eurozone growth" is not a reason they have stated is an aim of their program.

Were it their aim they'd need to be aiming for a much larger package and to intend to keep it running for longer until, let's say, growth (and inflation) were at 3%+ - no one expects them to do that and that'd probably face legal challenges were they to attempt it.

Out of curiosity, has the ECB ever taken a misstep in the handling of this crisis in your opinion?

I ask, because you seem to believe the current policy of the ECB is definitely not a correction to earlier mistakes. And because such was the terror and brimstone of the old normal about the potential evil moral hazards of ELA of a hundred billion euro. So terrifying was that to the ECB, that it justified extraordinary ECB action in 2010. It all seems overdone given the new normal.

View

View wrote: »

Given that Eurozone inflation was +0.3% in May, 0.0% in April and negative before that this year it is hard to see any basis for complacency on it.

Sure. If the person who takes that position understands absolutely nothing about inflation except that deflation must be inherently bad.

I assume you don't actually subscribe to that position, do you?

You have said youself that deflation (in fact, mostly disinflation) was largely down to the falling price of oil. But wait. Cheaper oil is correlated with higher demand in the economy, as well as falling input costs for manufacturing and exports.

It is only when you separate out the components of the price index that you can begin to determine whether or not disinflation or mild deflation is good, bad or indifferent. Falling oil and energy prices are good for the Eurozone; to claim they are as harmful to the economy as the effect of falling prices in real-estate and industrial goods is obviously ridiculous.

Well it is an innocent view shared by the ECB since "reviving Eurozone growth" is not a reason they have stated is an aim of their program.

Obviously, it is not a reason they have stated.

I'm not claiming that core inflation was not slightly low: when QE was announced, I think it was down about 0.2% on the previous year. So low, stable inflation. I mean it's hardly a big, jaw-dropping reason to undertake the most extraordinary, interventionist asset-purchasing program in the history of the Eurozone.

Were it their aim they'd need to be aiming for a much larger package and to intend to keep it running for longer until, let's say, growth (and inflation) were at 3%+ - no one expects them to do that and that'd probably face legal challenges were they to attempt it.

Where are you getting 3% from?
Where are you getting the idea that the magnitude of QE would need to be bigger?

The ECB is spending 10% of Eurozone GDP on QE. That is bloody enormous. Proportionately, it's roughly twice the amount the MPC spent on QE in the UK. Of course, the MPC didn't have to conceal its motives.

View

A Tyrant Named Miltiades! wrote: »

Sure. If the person who takes that position understands absolutely nothing about inflation except that deflation must be inherently bad.

I assume you don't actually subscribe to that position, do you?

You have said youself that deflation (in fact, mostly disinflation) was largely down to the falling price of oil. But wait. Cheaper oil is correlated with higher demand in the economy, as well as falling input costs for manufacturing and exports.

It is only when you separate out the components of the price index that you can begin to determine whether or not disinflation or mild deflation is good, bad or indifferent. Falling oil and energy prices are good for the Eurozone; to claim they are as harmful to the economy as the effect of falling prices in real-estate and industrial goods is obviously ridiculous.

Whether or not you or I think deflation is good or bad isn't the issue. That's a decision that falls to the ECB to make and they have made it with their decision to engage in a program to stave it off presumably after having considered both the positives and negatives of deflation V's inflation.

A Tyrant Named Miltiades! wrote: »

Obviously, it is not a reason they have stated.

I'm not claiming that core inflation was not slightly low: when QE was announced, I think it was down about 0.2% on the previous year. So low, stable inflation. I mean it's hardly a big, jaw-dropping reason to undertake the most extraordinary, interventionist asset-purchasing program in the history of the Eurozone.

I refer you to the statement made by Draghi when announcing the program. In it he stated it would run until Sept 2016 or until inflation is up towards the ECB's stated target of 2% over the medium term.

He did NOT state that the ECB will continue it until growth is at x%, so growth is not a deciding factor in their criteria. The clear implication is that should inflation spike upwards and growth flatline, the ECB is not going to continue the program and it will stop.

A Tyrant Named Miltiades! wrote: »

Where are you getting 3% from?

It was an example inflation rate chosen to make the point that they would not be launching the program were the inflation rate at that level.

A Tyrant Named Miltiades! wrote: »

Where are you getting the idea that the magnitude of QE would need to be bigger?

The ECB is spending 10% of Eurozone GDP on QE. That is bloody enormous. Proportionately, it's roughly twice the amount the MPC spent on QE in the UK. Of course, the MPC didn't have to conceal its motives.

The figures I saw (from articles at the time) were that the ECB program would amount to 7% of EZ GDP whereas the comparably UK one was 20% of GDP (and it hasn't set the UK economy on a stellar growth track). Also the comparable US one amounted to $3..6 trillion (after starting at $85 billion a month before tapering off 5 years later to $15 billion a month), the ECB one is for 2 years (or until inflation approaches the 2% mark) and is €60 billion a month (if I remember correctly).

View

Sand wrote: »

Out of curiosity, has the ECB ever taken a misstep in the handling of this crisis in your opinion?

Yes, of course, it has.

It was set up - by the member states - with a narrow remit focused on ensuring low inflation. As such its members have focused on that and have taken a conservative approach to dealing with it tending to err on the side of caution in the process. This may be as a result of style or legal advice but - imo - they could on occasion have adjusted rates more rapidly without endangering their goal.

A lot of the time I suspect their decisions are influenced by the fact that they will be challenged in the courts and that they feel they must be seen to be cautious when making them as a result (e.g. their OMT decision which only got the green light from the ECJ yesterday, although made in 2011 or 12).

Likewise, they have agreed to and/or been dragged into subsuming many of the tasks that should by rights have been handled by the EBA were the Euro in use EU wide. That has put them in a poor political position far too often.

In addition, they are - imo - inclined to take it easy on member states (which they really shouldn't be dealing with directly at all) and the banks of the member states (which they or the EBA should be dealing directly with) for far too long when they don't deserve it, thus leading to greater problems when they have to call a halt to this. A case in point in this would be the transaction that lead to the promissory notes here - that was probably illegal state aid and should have been challenged immediately by them (both politically and in court). Had they done so they would have saved themselves the whole palaver that occurred when it was finally unwound.

View

View wrote: »

Whether or not you or I think deflation is good or bad isn't the issue. That's a decision that falls to the ECB to make and they have made it with their decision to engage in a program to stave it off presumably after having considered both the positives and negatives of deflation V's inflation.

This has absolutely nothing to do with my post.You are blindly swallowing, and then regurgitating, ECB statements without the least bit of economic critique.

Do you accept, or not, that the dangers posed by disinflation and deflation are to be evaluated in the context of the components. You don't just take the headline rate and ignore all context. Do you accept that?

Because you see we know that household goods and real estate were stable and positive, whereas it was the possibility of a Chinese slowdown (external) and falling energy prices (external, petrol politics in the US & Middle East) that contributed to "the threat of deflation". It was not a Eurozone demand problem. Real estate and consumer prices were holding up. Core inflation was stable.

I don't deny that there was some cause to be concerned. We live in an interconnected world and nobody wants an oil crisis nor a Chinese crisis. But there was neither. All we had were falling energy prices which had been stimulating demand in the Eurozone, before QE was even announced.

How do you propose that QE would have increased inflation anyway? What mechanism?

You can't stick blindly to headline inflation rates. You have to look at consumer demand, and the wider context for the headline rate. How can anybody refuse to accept this?

From a price stability point of view, QE simply was not justified.

From a growth stimulation perspective, QE is easier to justify.