EZ: When Greece financed itself cheaper than the US


Ignacio de la Torre | Under the sponsorship of Bernanke, the US Federal Reserve pioneered an ambitious monetary policy which combined taking short-term interest rates to 0% with a huge expansion, not attempted up to now, of its balance sheet (Quantative Easing, or QE). Most of this comprised of buying government or mortgage bonds with a guarantee. Today, the US economy has experienced nine years of expansion, and the FED is normalising its policy by raising rates (which should advance towards al least 3%) and reducing its balance sheet at a rate of $20 billion a month, a figure which could increase to 50 billion a month in the near future. The well-known result is a rise in short-term rates (for example the LIBOR in dollars has risen strongly in the last few months, to 2.4%), as well as in long-term rates (the 10-year bond has already touched 3%, which affects many other investments).

The example of the US should serve as a warning for Europeans of what will have to happen. The ECB went further than the FED, pushing the deposit rates into negative territory. In other words, the cash the commercial banks deposit with the ECB is remunerated at a negative rate. At the same time, the intervention rates (the last resort lender) went to 0%. And finally, the ECB (via the Eurosystem) also embarked on a historic expansion of its balance sheet, in this case buying sovereign bonds and also investment grade corporate bonds. This situation has led to record high prices in bonds, with the corresponding record low yields. For example, the Greek government is today holding a two-year debt auction at a lower rate than that at which the US treasury sells debt (quite Kafkian in a way). And Spain, which has collapsed 13 times in the last 200 years, is financing itself at 10-years at 150 pips cheaper than the US, when historically it had financed itself at a premium.

As the Eurozone economy reverts to normality, unemployment falls (currently the rate is 8.3%, below the historic average). And assuming that core inflation rises slightly from the current depressed levels of 0.7%, the ECB will have to normalise its monetary policy in line with the Fed’s moves. At its end-July meeting, the ECB should use verbal intervention to warn us of the policy changes which are on the cards. Specifically, the purchases of bonds (QE) which currently total 30 billion euros a month, will drop to zero from January 2019. The deposit rate, which is now at -0.4%, will move to -0.2% during 2019 and later to 0%. At the same time, during the second half of 2019 the logical thing is for the ECB to begin to raise rates. These two factors should fuel a progressive rise in the Euribor from the summer of next year.

Many observers will be surprised by the fact that there is still an enormous amount of liquidity, some 700 billion euros, deposited with the ECB. Before the crisis, the excess of liquidity in northern Europe (current account surplus) was channelled via its banking systems to southern Europe in the shape of mortgage bonds, which would finance the propery boom. But after the crisis, the liquidity from the north was deposited directly with the ECB. In turn, the central bank recycled this for those countries with shortfalls, in the shape of debit balances for countries like Spain via the Target II system. That said, if prior to the crisis southern Europe had huge current account deficits (which explained the north-south flow), the revolution in its exports sector has allowed these countries, led by Spain, to have record current account surpluses now. This partly explains why the Eurozone as a whole has a surplus of 3.5% of GDP. This excess of liquidity, in a context where QE has depressed the returns on alternative investments, in my opinion explains the anomaly of the Euribor being in negative territory. Market interest rates (the Euribor and the like) will partly rise not just because of ECB intervention (towards 2019), but also because of an improvement in the demand for credit. This will be the result of stronger domestic demand, something which is already being seen in the US (the tax reform has accelerated this), but is still at an early stage in the Eurozone.

In my view, if the change in the ECB’s policy mentioned earlier materialises, the anomaly will correct itself, and in a few years we should see levels much more in line with those already noted in the US.