The European Central Bank announced recently the end of the currency printing, the so called Quantitative Easing. In addition, according to their announcements the balance sheet of the ECB should start to shrink from 2020. However, we have strong reasons to believe that it is not gonna happen and the central bank will change the rules of the game in order to save the economic situation, especially in the banking sector.
At the turn of 2011 and 2012, the European Central Bank granted the banks of euro area giving them large-scale loans.In this way 300 billion euros was created in December 2011, and 489 billion euros in February 2011. The interest rate of the loans was 1% with 3 years duration. Back then, hundreds of commercial banks have applied for almost interest-free capital.
It was simply a next currency print as a result of which the stock and bond markets started to rebound. To make this more difficult those loans were called Long-Term Refinancing Operations (LTROs). Those LTROs were repaid to the ECB in period from 2013 to 2015, which clearly was reflected in the bank’s balance sheet where we can see the shrunk during this period.
In the meantime, FED was running another round of QE acting like the “liquidity provider”.
However, after some time, the European Central Bank has returned to invite commercial banks for free capital . The idea was to protect the euro area countries from deflation. This time it was called Targeted Long- Term Refinancing Operations (TLTROs), i.e. loans with an interest rate of -0,4%.
The purpose of those loans was to provide cheap capital to commercial banks in order to give them possibility of providing inexpensive loans to companies which they could use for investing or avoiding bankruptcy. The currency created from the air was to stimulate the economy and raise inflation. TLTRO were granted twice – in 2014 and 2016. In both cases for a period of 4 years.
In addition to that, the European Central Bank decided to print currency in a typical way, buying government and corporate bonds (Quantitative Easing). This led to enormous distortions in the bond market. At the beginning, the scale of purchase was 60 billion euros per month, then they increased to 80 billion euros, and eventually it started to fall.
Particular changes in the ECB’s balance sheet divided into different operations are well reflected in the chart below. LTRO are denoted using blue, TLTRO using orange.
Source: Oxford Economics
It has to be pointed out that the above graph has one drawback. The actual total TLTRO value is 722 billion euros, while the chart suggests that it is much lower.
However, it can be clearly seen that the balance sheet of the European Central Bank in recent years has expanded enormously. The heads of the ECB decided that the period of prosperity could be restored by creating huge amount of the currency from the air. They completely ignored Mises who warned that “the inevitable consequence of credit expansions is the collapse of the economy. When this happens, a credit expansion is often considered to be the best medicine, which may lead to a temporary boom, but will certainly end up in a much more serious crisis.”
In our opinion this temporary boom was felt mostly by the representatives of the richest part of society, who could be profitable from selling their shares and bonds. The truth is that the poorer people do not own securities, instead they have to worry whether they will be able to cover their regular expenses (as we know raising the minimum salary also will not change this).
As we have already mentioned, recently the European Central Bank has reduced the scale of printing. This can be seen in the chart below for period 2015-2018.
According to the ECB latest announcements, the central bank has to end its assets purchases completely. It is a pivotal moment for the financial markets.
Firstly, buying bonds of the euro area countries by ECB artificially reduced their yields. This means that particular countries have paid less interest on their huge debt. In this way, the EU avoided a partial collapse, but in the same time became a hostage of this circumstance (indebted countries knew that they were protected by ECB regardless of their reckless policy).
Secondly, shares on the most important stock exchange in the world (US) had been following the movements of the central banks in the last decade. Since the central banks were mainly focused on injecting liquidity, share prices also went up. This is evident on the graph below which shows the comparison of the total balance sheet of the major central banks with the S&P 500 index.
However, currently central banks are gradually reducing liquidity from the financial markets. The Federal Reserve firstly ended printing and then moved to interest rate increases and balance sheet reduction. The Bank of Japan does not make large purchases in general – in the last year it bought 52 billion dollars of assets (the same amount which FED monthly sells). While the European Central Bank has ended the QE in the middle of December. As it is known the financial markets react to central banks actions in advance, which is why the shares performance in the end of the year was not so good.
What’s next with TLTRO?
The fact of ending asset purchases in the euro area means that market concerns are growing. Let’s not forget that the capital provided through TLTROs is still circulating in the economy. This is 722 billion euros which is the equivalent of over 6% of the euro area GDP.
If we get deeper into this we can see that since the first tranche of TLTROs which was issued in 2014 for a period of 4 years the ECB’s balance sheet did not shrink. This is because the repayment period of the majority of the TLTROs created from 2014 was postponed. All these loans provided for commercial banks (in 2014 and 2016) are to be repaid in 2020 (some of them also in 2021). It is worth to note that the value of non-performing loans of the same commercial banks exceeded 900 billion euros. Also as a result of new banking regulations, a part of the funds needed to repay the loans from the ECB is required a year before its maturity, i.e. in 2019. Therefore, a loop at the neck of some commercial banks begins to tighten.
According to Bloomberg, some commercial banks have already managed to hold talks with representatives of the ECB about risks related to TLTRO repayment. Two central bankers mentioned about this issue but with no details. French President Francois Villeroy said during his speech in Paris that “the issue of the TLTROs has to be taken into account”. Bloomberg also said that the subject of this program was discussed during the November meeting of the IMF. The question is whether they talked about extending the loans that expire in 2020 or about a completely new capital tranche that would have to be delivered to commercial banks.
The idea of maintaining or extending TLTROs, i.e. the so called currency printing may affect the currency market. Usually when the official end of QE (currency deterioration if you like) is announced, then it positively affects the currency quotes. This time nothing like that has happened. One of the reasons for this may be the fact that the market suspects that the ECB will not fully shutdown their printers.
The banking sector in Europe is in a terrible condition, to the extent that there is no way it will survive without the support of central banks. It is most likely that the European Central Bank will again get into the action and will do at least one of these two things:
1. Will postpone the repayment date of TLTRO loans maturing by 2020.
2. Will decide on the third TLTRO series, which of course will not be officially called printing, but an “economic support program” or something like that.
However, before that happens, the issue of further actions on TLTROs will be used during the negotiations with the Italian government. It is possible that this is happening right now because Italian politicians are slowly adapting to the demands of the EU.
Anyway, the further perspectives of TLTRO are very important for Italian banks. TLTRO program in some cases account for over 10% of the banks’ assets which is shown as a pink line on the chart.
We may assume, that the change of existing plans regarding TLTRO will negatively affect the euro.
The situation about the ECB balance sheet and the outlook of TLTRO means that we remain very skeptical about the future performance of the most of the European stock markets. On the one hand, the lack of fresh capital from the ECB will lead to a series of bankruptcies that will trigger a run off from the European stocks and bonds. On the other hand, if the central bank, maintans or enlarges the TLTRO scale, which is in line with our expectations, then it will be treated as a confirmation of the weak economic situation within the European Union.
Independent Trader Team