Aurelia Butler

The ECB has been pushing banks for years to factor climate considerations into how they lend and assess risk but lenders have failed to heed its warnings and threats of additional capital requirements. “Our analysis of 95 banks covering 75% of euro area loans shows that currently banks’ credit portfolios are substantially misaligned with the goals of the Paris Agreement, leading to elevated transition risks for roughly 90% of these banks,” ECB board member Frank Elderson said in a blog post. The overall credit exposure is comparatively small, however, worth about 189 billion euros ($206 billion) to business with assets in the oil and gas, coal, power generation, automotive, steel, and cement sectors, or roughly 5% of credit to firms, the ECB said in a new report.Of the surveyed banks, 13 had exposures in excess of 5 billion euros each to the six key transition sectors, which account for roughly half of total CO2 emissions in the euro area.Banks have been given until the end of 2024 to meet the ECB’s climate disclosure requirements, including how much they are deviating from the expected decarbonisation pathway. If they fail this, then additional capital requirements may be introduced, the ECB has said. “Transition planning must become a cornerstone of standard risk management, as it is only a matter of time before transition plans become mandatory,” Elderson said.A big risk for banks is that their actions deviate from their own communication. While plenty of banks say they take climate change seriously, their practices suggest complacency.”Seventy percent of these banks could face elevated litigation risks as they are publicly committed to the Paris Agreement, but their credit portfolio is still measurably misaligned with it,” Elderson said.($1 = 0.9186 euros) More

This article is an on-site version of our Chris Giles on Central Banks newsletter. Sign up here to get the newsletter sent straight to your inbox every TuesdayIt has been a difficult week for the small army of economists at the European Central Bank. Many will be reeling from the tongue-lashing they received from their President Christine Lagarde in Davos, calling them and most other dismal scientists a “tribal clique” who do not think outside their small world (watch at 13:30 minutes in). There is evidence some bad feeling is mutual. Were her words correct and wise? Email me: [email protected] interest rate landscapeCentral bankers have given many interviews and speeches in the past week, and one unifying feature is that officials hate U-turns. They would prefer to wait, act slowly and risk being late rather than reverse course. As Krishna Guha, vice-chair of Evercore ESI, put it: What we think some in the markets have been missing — or not putting enough weight on — is the central banks’ shared fear of starting too soon and having to stop or reverse course.Some examples of this tendency include Christopher Waller, the Federal Reserve governor, speaking last Tuesday, who said:The key thing is the [US] economy’s doing well; it’s giving us the flexibility to move carefully and methodically; so we can see how the data comes in, see if progress is being sustained. The worst thing we’d have is if it reverses and we’d already started to cut [rates]. (21:00 minutes in)He was echoed by Lagarde last Wednesday: The risk would be worse if we went too fast [with rate cuts] and had to come back to more tightening because we would have wasted all the efforts that everybody has put in the last 15 months. (30 seconds in)As central banks meet for monetary policy decisions over the coming 10 days, we therefore have to expect officials to be in wait-and-see mode. That said, each of the four major western central banks have their own specific challenges to address.Bank of JapanThe Bank of Japan is different in two respects. It is considering an interest rate rise rather than cuts and has already finished its meeting. Contrary to many economists’ predictions last autumn, the BoJ again left interest rates at -0.1 per cent and did not signal an imminent end to its policy of negative interest rates. It also left yield curve control unchanged, having loosened it in October, to have 1 per cent as a reference point for 10-year Japanese government bond yields rather than as an upper limit. This reference point is currently not binding. The main reason for the BoJ’s caution is that inflation and wage growth data have been weaker than expected, casting doubt on the BoJ’s ability to hit a 2 per cent target sustainably. The Committee still expressed confidence that after weaker energy prices lowered inflation in the 2024 fiscal year, a “virtuous cycle” between wages and prices would emerge, ensuring inflation would stabilise around the 2 per cent target rather than falling below. The BoJ’s confidence here is low, however, and it wants more evidence before ending negative interest rates and raising the policy rate. A symbolic rate rise to zero per cent in April is still expected, but it is a close call and will depend heavily on wage data in the coming months. You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.Federal ReserveThe Federal Reserve is probably in the best position, ahead of its rates decision on January 31, because inflation is moderating without an economic downturn. There will be no explicit policy change and the main focus will be the signals sent by the Federal Open Market Committee regarding the speed and number of interest rate cuts to come this year. Financial markets have expected the first cut in March and five further reductions in 2024, while the FOMC’s economic projections from December suggested only three quarter-point rate cuts were likely. The key issue is that Fed governors want evidence if they are to cut rates faster or more extensively. This would require inflation falling more rapidly and sustainably than expected or some bad news on jobs from the labour market. While there is plenty of time before the March 20 meeting for this evidence to arrive, we have not seen it yet. You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.Markets are beginning to take note. Accordingly, the CME Group FedWatch Tool now has a less than 50 per cent financial market expectation of a March rate cut. As the chart shows, the Atlanta Fed market probability tracker for March 2024 still gives an 80 per cent chance of a rate cut. The difference arises because, while the Atlanta Fed uses a more sophisticated algorithm to generate the probabilities, it bases them on three-month options in the secured overnight financing rate (SOFR) market, a period starting on March 20 and ending on June 18. Nearly everyone expects a rate cut by the June meeting. European Central BankThe headlines last week suggested that the ECB was rejecting the popular idea in financial markets that it would cut rates in the spring, but the reality was more subtle. For sure, Lagarde said she wanted to avoid cutting rates too early, but she also said that it was reasonable to think the central bank would cut its rates by the summer if there was not a further inflationary shock. Previously, her blanket response was that it was far too early even to talk about rate cuts, so her new statements were an acknowledgment that policy priorities are shifting in Frankfurt. The key reason for the delay was to give the ECB time get sufficient evidence in late spring that high wage growth did not present a continued inflationary threat. The eurozone does not have a comprehensive, accurate and timely measure of wages, but they are growing much faster (at about a 5 per cent annual rate) than a rate consistent with the 2 per cent inflation target. You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.However, as Philip Lane, ECB chief economist, has noted, there can be a period of wage catch-up after an inflationary episode to rebalance profits and wages, dependent on trends in productivity and import prices. As the chart shows, nominal wage levels have fallen significantly below price levels in the eurozone on all main measures and some catch-up in wages is justified. It is therefore likely that the ECB will wait, but a weakening in the economic outlook would prompt an earlier move if it was also paired with further good news on inflation. Bank of EnglandIn many ways, the BoE has the biggest task ahead in its meeting on February 1. It needs an entirely new economic narrative to accompany its refreshed economic forecasts that are bound to change significantly. With inflation in the final quarter of 2023 much lower than expected and energy prices well down on the Monetary Policy Committee’s November forecast assumptions, CPI inflation is now likely to fall back to the BoE’s 2 per cent target in the April or May data this year. In the November forecasts, the MPC thought it would achieve this milestone only at the end of 2025. The key conditioning assumption changes are shown in the following chart. You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.The change in the outlook is likely to lead to an end of votes to raise interest rates further from the three hawks on the MPC who voted to raise rates from 5.25 per cent to 5.5 per cent at the December meeting. Jonathan Haskel has already indicated a change of view on X. As the chart shows, market expectations have priced in four quarter-point rate cuts this year and another three next year. The MPC is likely, therefore, to perform a pivot at this meeting. Two questions arise. First, whether the MPC implicitly validates the forward curve in its new inflation forecast, suggesting interest rate cuts as soon as May. Second, whether Andrew Bailey can manage to present the huge forecast revisions as a triumph of policy or whether it is seen as another blunder by the BoE. This has to be his best chance yet to score a communications victory. But, with the BoE, you never know. What I’ve been reading and watchingMy newsletter about the lack of evidence proving the “last mile” of inflation control is the hardest received academic support from the Atlanta Fed. “After examining a number of potential mechanisms, it is difficult to conclude that the last mile of disinflation is more arduous than the rest,” the paper by staff member David Rapach concludes. In a speech on Monday, Augusto Carstens, the often hawkish head of the Bank for International Settlements, said he now viewed the economic landscape with “cautious optimism”, saying inflation did not get embedded as he had feared. Obviously, he added that success must not breed complacency. In her column, Soumaya Keynes wonders how a new Trump presidency would affect the Fed. She’s exactly right to expect jawboning to keep interest rates down and ultimately a new Fed chair. There is not yet a settled name for a Republican replacement of Jay Powell in 2026, so a lot to play for and quite a bit of concern given some of the names she mentions. Over at the Long View, Katie Martin notes there seems to be only one thing that matters to financial markets this year — the path of interest rates. All the more reason to follow this closely.The Office of Inspector General, which oversees the Fed, has issued a long-awaited report into the trading activity of two former top Federal Reserve officials, Robert Kaplan of the Dallas Fed and Eric Rosengren of Boston — both of whom resigned in 2021. Their trades created an “appearance of conflict of interest”, it said, although its main conclusion was that no laws were broken or lasting damage done.Recommended newsletters for you Free lunch — Your guide to the global economic policy debate. Sign up hereUnhedged — Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here More

SHANGHAI/NEW YORK (Reuters) – From hope to hesitancy and now total capitulation, global investors in China are heading for the exits in the world’s second-biggest economy and sending its stock market crashing.Stock markets in Hong Kong and Shanghai tumbled on Monday — the Shanghai index marking its worst day since April 2022 — as investors retreated from what was a ‘must have’ country in global portfolios just a year ago.The selling seemed to subside on Tuesday as Chinese Premier Li Qiang chaired a cabinet meeting and Bloomberg News reported authorities were considering a package of measures to stabilise the market. Investors were unimpressed.”There is a degree of capitulation,” said Derrick Irwin, an emerging markets portfolio manager at Allspring Global Investments. “Until there is a bigger crisis, the Chinese government may just continue to kind of throw cups of water on the fire, instead of something big that they probably need to do.” Allspring has been underweight China since last year. This week’s selloff was a culmination of months of frustration over the direction of the economy, particularly the often-opaque regulatory changes that thwarted China’s post-pandemic recovery last year. China’s benchmark CSI 300 Index has slumped 47% since it peaked in February 2021, while the Hong Kong HSI stock index has sunk 49%. In contrast, Japan’s Nikkei Average and the U.S. benchmark S&P 500 are up 24% each.The Shanghai and Shenzhen exchanges have wiped out $3 trillion of value since the end of 2021.BIG MEASURES NEEDEDAnalysts at Goldman Sachs noted much of the negativity around China was priced into the stock market. But a turnaround will take time and require big policy measures, including forceful and comprehensive easing, stimulus, better Sino-U.S. relations and even government backstops in the housing and stock markets, they wrote.Tony Roth, chief investment officer at Wilmington Trust Investment Advisors, plans to scale down his already underweight position on China due to a loss of confidence in the country’s economic activity and regulation.”In general, our emerging markets managers are underweight China, and we are increasingly picking and working with managers that have greater underweights to China,” he said. Any hopes that 2024 will be different were nipped early by hints from authorities that they will overlook short term hiccups as they pursue healthier, long-term growth.Support for the battered property sector that underpins much of the economy has also been fitful, even as the Communist Party has vowed to boost oversight of the country’s $61 trillion finance industry and local governments.Marko Papic, chief strategist at the Clocktower Group, said a heavy-handed regulation of the finance sector is not what China needs now. “After a crisis, you need banks to have animal spirits and to feel like they should lend, so if you crack down on them, it’s going to slow down the recovery.”An eagerly anticipated policy rate cut this month didn’t come through, either, which Papic said showed “we’re really far from any sort of a bazooka … they’re not even willing to fire a water pistol.”A ‘MICRO’ STORYWhile investors have flocked to India, Japan and other emerging markets, some overseas money still remains in China, belonging to pension funds and others whose products are indexed to MSCI’s emerging market index, of which China comprises more than 26%. Estimates from the Institute of International Finance show a $82.2-billion outflow from China portfolios in 2023, while emerging markets excluding China saw $261.1 billion in non-resident portfolio inflows. Dozens of exchange-traded funds also hold the country’s equities. Yet, the compulsion to own a piece of the nearly $18 trillion economy has given way to discretion, says Norman Villamin, group chief strategist at UBP, which lowered China to underweight and raised India to overweight in October. “Over the last 30 years, the story of China has been China is growing fast, China is becoming the manufacturing center of the world. So you should just own China because the economy is doing very well,” Villamin said. Now, it is less of a ‘macro story’ and more a ‘micro story’ about owning a few good companies there, he said.BAND-AIDMainland investors are meanwhile unenthused by the Bloomberg News report that policymakers may mobilize about 2 trillion yuan ($278.98 billion) for a stocks stabilization fund. The Shanghai index closed below the psychologically key 2,800-point mark on Tuesday. “It’s like crying wolf,” said Simon Yu, vice general manager at Panyao Asset Management. “Talks about the rescue fund have been swirling for a long time, but haven’t yet materialised.”Local analysts have been calling for the set up of a rescue fund since last year. There’s precedence. A “National Team” was set up during the 2015 stock market crash, comprising a group of investors that included state fund Central Huijin, China Securities Finance Corp and investment vehicles under China’s forex regulator. Their buying lifted the stock market, but just briefly.Yu said market confidence could return if the government made it clear that it would buy stocks worth several hundred billion yuan every year. “If there’s nothing concrete, only vague rhetoric, investors expectations will remain pessimistic.”Singapore-based Daniel Tan, a portfolio manager at Grasshopper Asset Management, said the proposed amount for the fund is small “compared to the size of the problem” but could signal a change in authorities’ strategy.”We will adopt a wait-and-see approach for now. There is plenty of upside if and when the market starts to rally, we are not motivated to pick the bottom.” ($1 = 7.1691 Chinese yuan renminbi) More