Blain’s Morning Porridge – May 6th 2020
“Let us sing more cheerful songs, more songs full of joy!”
I am wondering if my FT App is broken? I opened it this morning and the front pages of the Pink Un didn’t rate the German Constitutional Court’s stab in the back of the ECB an appearance on the top line? AirBnB and the Swiss National Bank did, but the German/ECB spat did not. (In an editorial the FT called the decision “misguided”.) I know the teenage scribblers know far more about what’s important to markets than grizzled old bond market veterans like myself… but I did think a German court overruling the European Court of Justice was pretty critical stuff.
Yesterday I tweeted the German court ruling was an opportunity to buy a dip in Europe. Italian bonds widened. On previous form, any European mis-speaking or dissent is followed by some furious back-peddling and mumble-swerve, quickly allowing the issue to be kicked further down the road. You then wait for Italy to tighten, sell, and wait for the next crisis to buy them back cheaper. Eat, Sleep, Repeat.
But this time it’s shaping up with considerable potential to become something more serious…
After a couple of calls last night, I detect something of a more fundamental wobble underway in Europe. Lines are being drawn. It’s been obvious for a long time the three strands of the European dream; National Politics, The ECB and The European Union are falling out of alignment. There is little shared vision between France and Germany, the ECB is knotted in compromise, while national politics face increasing populism. Together these spell a sense of deepening trouble.
The German case is not simple, but the German Constitutional Court requires the ECB to provide evidence of “proportionality”: The ECB must prove it has fully considered the economic and fiscal effects of it’s QE sovereign bond programmes in terms of ongoing effects. It will do so with ease.
Market commentators, including myself, have long argued QE programmes have absolutely distorted market prices across all asset classes, grossly inflated the price of financial assets, and have created dire future consequences for the European economy in terms of unemployment and disincentives to growth and investment – but these aren’t issues the ECB is ever likely to admit with its limited monetary stability mandate. They are very aware of these consequences, but to admit them would be.. troublesome.
The Germans are not the villains of this story. No one is. They know the reality of QE consequences, but are particularly concerned the rules around monetary financing are being chipped away by successive crisis. Ultimately, Germany is not going to accept German workers financing the pensions of other European nations.
Politically Europe is still reeling from the UK exit. It’s broken the budget and shattered many of the illusions about alignment, the prospect for closer union, and emphasised the political divides that exist in all European nations about surrendering national leadership to the EU. The referendum highlighted consequences: German politicians can’t write unlimited cheques to Brussels. Italian politicians desperately need them.
The German court ruling is unlikely to be the straw that breaks the Euro’s back, but it’s part of a “crumble” that’s causing European assets to underperform. Increasingly global investors perceive just what an impossible situation now faces Europe in terms of political and market consequences. Europe’s complexity makes solving its problems just too difficult.
It’s going to get worse:
Firstly, the German court has cleverly put defined limits on future ECB QE. Although it accepted the pre-Covid QE programmes were not monetary financing in breach of Euro rules, it restated the rules about purchases being clearly linked to the existing ECB capital key (limiting the proportion of any nations debt the ECB can buy), the limit on purchases of any issue, and the requirement of an investment grade rating. It means the Germans have effectively reserved the right to declare the new Pandemic QE Progammes (PEPP) to be illegal if they breach the rules they just confirmed.
The Bundesbank and ECB have long been uneasy bedfellows. Yesterday, the Bundesbank’s head Jens Weidmann, arch-anti-QE campaigner, quickly confirmed the German Central Bank (or branch of the ECB depending which side you are on) will “assist” the ECB to justify its bond buying programme – which gives him the platform to weigh in against new programmes.
That immediately puts Germany on collision course with Southern Europe – which desperately requires fiscal inflation through massively enhanced QE. Without it, Italy and Spain spreads will balloon wider, and a new European Sovereign debt crisis is nailed on. The German Court just said NO..
The Second issue is Rules. If a German Court can rule the European Court of Justice’s (“ECJ”) previous rulings on QE were “untenable from a methodological perspective”, then it must be a superior court. The German court has clearly put itself above the ECB in determining monetary policy for Europe. As a member of the Euro, Germany signed up for EU, the single currency and all their attendant rules – which includes the ECJ as the top court, and the ECB as the competent monetary authority which it must support.
The whole rules-based logic of the EU, the ECB and the Euro just vanished in a puff of smoke.
The message to the rest of Europe is clear. If German courts Trump ECJ rulings and ECB policy, what kind of union is it? Or is it just an informal club where you can pick and choose the rules you want to follow, and ignore the rest. If rules don’t apply to Germany, then how can they apply to anyone else? The Eastern Europeans are lining up with the stuff they don’t like.
The third issue is the breakdown in EU politics. At the heart of all Europe’s problems is domestic self-interest vs the attractions of being part of European Union. Broadly, the UK voted narrowly in favour of ill-defined self-interest, and much of Europe is now looking enviously at us. (Not because Brexit was a good idea.. but it’s looking a slightly better option than remaining within a fracturing permanently depressed Europe.)
What are the likely market effects?
It depends on how the immediate crisis is handled, but I expect to see a more sustained widening as the implications of the German Court sink in, further underperformance in European stocks and the Euro to remain weak.
The real issue is the European Project. I don’t expect it to unravel, and I don’t see there being a single political straw that breaks the Euro. I suspect we’ll see a whole cascade of troubles, making a bad situation worse!
As Greece discovered the costs of leaving are even more horrific than remaining! That remains true for the whole Euro membership – they are trapped. Some suggest Germany leaving would be a solution – but that could cripple the rest even worse!
Three Things too Read This Morning
Out of time, and back to the day job…