ECB Capitulates But Markets Call BS – Why?

Markets were a sea of red last night on growing concerns about the slowing global economy we discussed yesterday.  But there was something particularly remarkable and telling about last night’s losses that speaks to the burning question on many people’s lips – “what happens when the Fed starts QE4”?  i.e. the Fed has fuelled an epic rally off the 2018 correction by halting its tightening program.  If we get a real crash or recession and they turn on Quantitative Easing for the 4th time, what will happen?

We have written at length of the ‘no bullets left’ situation many believe we are in, whereby the Fed is coming off too low a base to effectively bailout a crash. i.e. they have little room to lower rates and their balance sheet is already over $4 trillion.  It’s the same for all other major central banks.  There is also the school of thought that such a move would instead see a broad-scale loss of confidence in the entire economy and you can only suck forward so much future growth and consumption.

Last night may have been instructive in this regard.  The ECB (European Central Bank) is already the world’s biggest with a balance sheet of over 40% of Europe’s GDP.  That balance sheet has grown through an epic and protracted QE program buying all manner of European bonds with freshly printed Euros.  They also still have a negative cash deposit rate, yep, negative. They stopped QE and have been talking up tightening further however last night they capitulated in a very big way off the undeniable slowing, and near recessionary, Euro economy together with inflation turning down again.  They held rates unchanged and indeed forecast that to remain until the end of 2019, and launched the 3rd attempt at what they call Targeted Long-Term Refinancing Operations (TLTRO’s) in lieu of QE which they concede didn’t work.  Simplistically TLTRO’s lend money to commercial banks at ultra low rates to promote, you guessed it, more lending.  How low?  Try minus 0.4%.  Yep, they are paying the banks to borrow.  Nothing fixes a debt born crisis like a bit more debt…. Now normally such an announcement of further stimulus is met with unbridled (and unthinking) joy from markets and a stimulus rally ensues.  But last night that was most certainly not the case.  European markets tumbled, particularly the banks, as did the US.  Gold did well to hold it’s own given the surge in the USD against a plummeting EUR.  It seems the markets are either not buying it, or they think its not enough.  This could be that loss of confidence mentioned earlier.  At some stage if you are buying shares as an investment in future growth and the only thing supporting their price is central bank stimulus and more debt, maybe, just maybe the markets are calling BS.

Remember the price is what you pay, the value is what you get.  As the world heads towards a recession, where is the future value?

Lance Roberts of Real Investment Advice has yet again penned an insightful, well constructed piece on that burning question “QE – Then, Now, & Why It May Not Work”.  He outlines why further stimulus off this current base is unlikely to work.  We thoroughly recommend you read it.  The link is here.  Spoiler alert, his summary is:

“It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade and there is rising evidence that growth is beginning to decelerate.

While another $2-4 Trillion in QE might indeed be successful in further inflating the third bubble in asset prices since the turn of the century, there is a finite ability to continue to pull forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle. There is evidence the cycle peak has been reached.

If I am correct, and the effectiveness of rate reductions and QE are diminished due to the reasons detailed herein, the subsequent destruction to the “wealth effect” will be far larger than currently imagined. There is a limit to just how many bonds the Federal Reserve can buy and a deep recession will likely find the Fed powerless to offset much of the negative effects. 

If more “QE” works, great. But as investors, with our retirement savings at risk, what if it doesn’t.”