Liquidity driven markets seek more from the ECB

The broad market narrative during April has very much been one of looking beyond the current economic damage and towards an eventual recovery. An impressive month of equity market performance was showing signs of fatigue today, with April drawing to a close, but there is little doubt that the stark divide between dire economic figures and rebounding asset prices has been bridged by massive liquidity infusions from central banks.

In any race, there are laggards and Europe has one hand on the wooden spoon at the moment. This reflects in part the lack of a truly unified financial system with a common Treasury for the eurozone. The recent tightening in eurozone financial conditions — offsetting monetary and fiscal efforts — has been sparked by a split between EU countries over how additional public spending is ultimately funded.

Such an impasse increasingly looks absurd given the tone of economic data before the full hit from lockdowns across Europe registered. The eurozone economy contracted 3.8 per cent during the first quarter compared with the previous quarter, the fastest rate of decline since records began in 1995.

Fresh after the Federal Reserve signalled a determination to backstop the US economy and financial markets for however long it takes, the European Central Bank policy meeting statement and press conference with president Christine Lagarde today sought to emulate that approach. A chilly market reception was summed up by Andrew Mulliner at Janus Henderson Advisors:

“Ultimately, as expected the ECB is talking a good game, but it is struggling to match the verbiage with action when set alongside its central banking peers.”

In spite of a view in some quarters that the ECB has time on its side in terms of expanding its current bond purchases — action that should narrow the spread between the likes of Italy and Germany — and perhaps expand its balance sheet towards high yield debt for example, market sentiment is clearly impatient and wants stronger evidence of proactive central bank thinking.

That starts with boosting the firepower of the current €750bn Pandemic Emergency Purchase Programme that was announced in mid-March.

In that respect, Ms Lagarde indicated that the size of the PEPP will probably increase and that it will run further — into next year — while again highlighting the importance of fiscal policymaking a hefty contribution.

Anna Stupnytska at Fidelity International warns:

“The euro area is already lagging its counterparts in the developed world on policy support. To ensure a decent recovery as economies gradually open up after lockdown — without amplifying internal imbalances — will require significant fiscal stimulus. The risk of a sovereign debt crisis involving Italy is not trivial — to avoid this scenario will be an enormous challenge for policymakers in the coming months.”

One bond market solution, argues Claire Jones of FT Alphaville, is that of the ECB explicitly targeting sovereign yield spreads.

Ultimately, the ECB will need to do more and as Saxo Bank’s Christopher Dembik notes:

“Based on our calculations, eurozone government need to roll over almost €2tn in debt and finance new net issuance of about €1.5tn this year. The ECB’s commitment to buy only around €1tn is understandably insufficient. We expect that it will need to increase total asset purchases by at least €500bn this year to absorb coronavirus debts.”

Another way of gauging how Europe lags the policy response seen to date in both China and the US is highlighted by Dhaval Joshi at BCA Research, via the evolution of bank credit flows and bond yields over a six-month period, as shown here:

“The six-month increase in US bank credit flows, at $660bn, is the highest in a decade (this does reflect companies drawing down on credit lines with lenders) and not far from the highest ever. In China, the equivalent six-month increase is $550bn. But in the euro area, the six-month increase in bank credit flows amounts to an underwhelming $70bn.”

In its policy statement the ECB stated that it would lend money at minus 1 per cent to banks and it launched a fresh round of unconditional repurchase operations to inject liquidity into the financial system.

This exercise in finely calibrating the ECB’s policy response failed to stem market anxiety, with eurozone banks extending their share price declines, while peripheral bond yields edged higher versus that of the German Bund.

Seema Shah at Principal Global Investors said:

“Essentially, the ECB’s chosen strategy seems to be sweetening banks in order to convince them to lend into the real economy.”

Longer term, TD Securities argues that the eurozone faces quite a challenge recovering from the economic legacy of the pandemic:

“As supply chains remain impaired and aggregate demand falls, we rather think that the balance of payments will be magnified in this crisis. There will be a dramatic shift in trade balance and capital flows. Both will be weak spots for the euro, while the latter will be particularly supportive for the broad US dollar.”

Quick Hits — What’s on the markets radar?

There has been a disturbance among the oil majors. Royal Dutch Shell has cut its dividend for the first time since the second world war. Earlier this week BP affirmed its dividend, but in a nod to how the clock is ticking given the challenges facing the sector, the company indicated it would review payouts for the second quarter.

AJ Bell’s Russ Mould notes:

“Shell paid £11.6bn in dividends in 2019 which accounted for 15.4 per cent of all FTSE 100 payments last year. Therefore its dividend is not only going to hurt its own shareholders but also people who own funds tracking the total return of the FTSE 100 index which includes dividend payments.”

A glimmer of optimism is whether Shell’s action marks a nadir for oil. Higher futures prices in 12 months suggests that current production cuts and the return of demand does lay the ground for recovery.

The latest purchasing managers’ index data from China for March highlighted weakness in export and import orders as the global economy endures the great shutdown. It also adds to deflationary pressure in China and hardly helps the profit outlook for exporters.

Still, TD Securities doubts Beijing will sanction a weaker renminbi “as a tool to boost trade, especially as a weaker currency will do little to boost exports at a time when external demand is collapsing”.

Source: Economy - ft.com