Question.: Inflation in the US is picking up. Do you think this may change the course of the monetary policy and accelerate an interest rate increase?
Answer.: No. I think the monetary policy will not change. I believe the Fed is very confortable with how things are going. It has a script for the monetary policy and financial markets are included in it.
Q.: There are some people (such as former economic advisor Alan Krueger) who consider that short-term unemployed easily finding a new job in the US is a sign that wages inflation will begin to grow.
A.- I don’t buy that theory. Krueger’s analysis is sound and convincing but there are other analysis as sound and convincing as his that say exactly the opposite. While inflation expectations are fixed in 2%, there is no cause for concern. Even if we surpass the inflation target by a little, there won’t be any problem. The US has an unemployment problem, not an inflation problem. There is nothing wrong with heating inflation up a little bit, as long as it is only for one or two years.
Q.: In Europe the risk is the opposite: deflation.
A.: I’m less optimistic there. Of course, Europe is now in a much better situation than 2 or 3 years ago. With Mr Draghi, the ECB does things right. It is slow but effective. I’m a little sceptical regarding the impact of the negative interest rate in the deposits, but I think it is going in the right direction. However, it is not enough. The key is the advance of the banking market integration as well as the credibility of the stress tests (so as to let banks strengthen their capital). That’s where I feel skeptical.
A.: First, I must say that these stress tests seem much more serious than the previous ones. It is also true that the macroeconomic scenario is now more positive. However, it is still rather weak. What is most worrying is the lack of a clear mechanism capable of recapitalising the banks if they are unable of raising enough capital in the market.
Q.: But in that case, governments will come to the rescue…
A.: And that is the heart of the problem. There may be governments that don’t have the necessary resources or political will. Right now, the credit growth in the Eurozone is still negative, which is not consistent with a sustainable growth in the long term. It is necessary to have a well capitalised banking system. My question here is: will the stress tests establish a well capitalised banking system? I doubt it. And, without credit growth, there is no sustainable economic growth.
Finally, there is the problem of defining what happens in France and Italy. They are both two big economies in need of many more reforms. It seems they have admitted this reality, but they are progressing slowly.
Q.: Is there going to be some quantitative easing in the Eurozone?
A.: I think so. But it won’t be the product of a low inflation, and it won’t be this year nor the next because global economy is now moving in the right direction. As long as things are the same, the QE won’t be necessary. However, when there is a slowdown in the global growth (whenever it happens), the Eurozone will be under a huge pressure. Then, it will be obvious that the reforms in France and Italy weren’t enough, and that the banking integration wasn’t enough either. This scenario will come in a moment of low inflation, so there won’t be many alternatives apart from a quantitative easing.
Q.- The scenario you are talking about is quite ‘Japanese.’
A.- It is totally Japanese. Right now the situation is relatively favourable because all problems in Russia and in the emerging countries have forced investors to change their strategy and focus on the Monetary Union. The timing of the Ukraine crisis was perfect for the sovereign debt in countries such as Spain and Italy, and it explains the fall in interest rates. It also explains the “boom” in the household prices in places like London, Vancouver, Toronto, New York or San Francisco. But in the next two years, we will have zero credit growth in the Monetary Union. That will leave the area in a very vulnerable situation.
Q.- The bond market doesn’t react in the face of the expectations of monetary tightening. Stock exchanges volatility is at minimum levels since before the crisis. What about the boom in high yield bonds issuances?
A.- That is disturbing. I think in the next two years the greatest risk of instability will be in the corporate bond markets, such as the so-called collateralized loan obligation ior CLO (i.e. credit securitisations for businesses). I believe it is overheating and regulators are aware of this.