Ad Hoc Commentary – Europe to do quantitative easing into a fragmented financial market?
Everyone is focused on the American Federal Reserve’s tapering, and too few are focused on the possibility of Europe embarking on quantitative easing (QE), i.e. printing money. The most important data point this week is the Eurozone’s harmonized inflation number that will be released on Friday. Many now believe that if inflation in the European monetary union continues to print lower, the European Central Bank will embark on QE. Since Europe is stuck in German-led austerity and thus high unemployment, it is almost guaranteed that we will get low CPI numbers in the future, and thus European version of QE.
However, in the absence of a federal debt, i.e. Eurobonds, the risk of Europe QE policy spill-over into other markets is extremely high. One can only imagine the unintended consequences if the Federal Reserve printed money to buy Detroit’s and California’s municipal bonds instead of the Federal Debt. One of the biggest problems in Europe is that small and medium enterprises, especially in the PIGS nations, are finding it close to impossible to get credit. Printing EUR 400 billion to buy 30% German bunds, 20% French Oats, 18% Italian BTPs, 12% Spanish Bonos, and 20% others will not unfreeze credit to those who need it most. On the contrary, it will make the cost of credit cheaper in Germany relative to Greece. That is not the way to rebalance the imbalances within Europe, and will only fuel the vicious cycle of lost PIGS competitiveness. And capital, seeing this eventual outcome that will put the social fabric to strain will likely leave for America.
In any case, the person to watch closely is Mario Draghi. The webpage to watch closely is perhaps the Financial Times theme on Europe QE:
And the trade to put on if they decide to do QE in Europe is to short the EUR/USD. For the record, yours truly had said that this is the year to finally short the EUR/USD because the European sovereign debt crisis had returned to Europe. Yours truly admit that this had been a bad trade so far – before carrying costs, the EUR/USD is about where it started on Jan 1, but the journey had been a nerve wrecking one for day traders. However, the catalyst to finally short the currency should be the European QE. And perhaps that is what the European technocrats want anyway. It will not solve European imbalances because Europe lacks a federal debt. Of course, one can always argue that if ECB bought corporate paper it would have eased credit where it is needed most. Though that is an economically good solution, it is a politically bad solution. Why should politicians give money to the business elite when the politicians can have the money for themselves?
Perhaps the best solution is to create a Europe-wide standardized infrastructure asset backed security market as we have always talked about. In that way, the market will have an attractive investment class which has long-dated investment-grade cash flows that match long-term liabilities. Of course, since infrastructure is usually seen as a basic societal need that government should provide, it will have the added benefit of an implicit government guarantee. Also politicians will likely have very little resistance to channeling money into infrastructure asset backed securities. One would just need to put in legislation to minimize the political risk, thereby protecting investors from the whim of government subsidies and policy; and safeguards to minimize corruption.
Good luck in the markets.