Blain’s Morning Porridge – 21st Feb 2019 – ECB Day

Blain’s Morning Porridge  – 21th February  2019

“Lenin was right. There is subtler, no surer means of overturning the existing basis of society than to debauch the currency.”

In the headlines this morning:

I must post this line from one of my favourite Financial sector commentaries – Duncan Farr of Jeffries who covers banks: “Here we are 5 weeks ahead of Brexit, and the top 2 performing banks in Europe are Lloyds followed by RBoS.” If you ever wanted a clearer hint the supposed Brexit crisis and imminent collapse of UK plc might just be a fictitious political construct, then there you are.  Its fascinating just how sanguine the markets have become about the divorce. Sterling is up and who cares?

I have often been told I worry about all the wrong things. According to BAML, (reported on BBerg), the biggest fear of European investors currently is a Worldwide Economic Slump, with 30% of respondents citing it as their primary worry. Yep. I can see why that would be an issue. Only 2% of European investors surveyed by BAML rank Brexit as their primary fear. It’s not even in the top 5! (For the record, my primary fear is a Global Liquidity Storm – the sudden and catastrophic drying up of liquidity following a shock..)

Politics and markets are intertwined, but… maybe no longer in the case of Brexit? It’s just become background noise – meaning it; doesn’t matter, or we’re overly complacent. UK politics has never looked so dire. Markets appear increasingly disinterested. A new UK political party, and unstated threats a whole slew of ministers are set to resign if we get/don’t get a Brexit deal. Rumours are a deal is already inked with Brussels. Rumours are the Tory Brexiteers will reject it – whatever it says. It Theresa May is capable of getting together a deal in parliament – then this would probably be a good time..

It’s beginning to get silly. If I was an Irish farmer, I’d be more than a little concerned by Michael Gove’s comments about imposing the 57% tariff allowed by WTO rules on the 37% of Irish food production sold to UK consumers. (Ouch!) The Irish have gone bleating to Brussels, where the Irish agri-kommitzar has already promised them aid. If I was UK consumer, I’d be concerned at Gove unravelling cheap food and the corn laws. Ouch again. (For the record, I find Cornish butter to be rather nice..) Maybe, just maybe… Gove is laying out a negotiating position?

Let’s just hope I’m right, that Brexit doesn’t matter, and it’s just a millennium bug swimming in a slightly agitated tea-cup. Maybe we’re all wrong. Perhaps we are all worrying about the wrong stuff. Maybe its more simple? Today is ECB day. How exciting.

Notwithstanding the fact two domestic UK banks are the top performing in Europe, yesterday I suffered a moment of profound melancholy while perusing the news wires. I was reading an article on The ECB and it’s need to keep the European banking system awash with cheap cash. I sighed.

I feel like I’ve squandered the last decade questioning the dubious logic and market distortions implicit in ECB actions to shore up European banking and sovereign debt. Why? Because.. I really don’t want to have to give a lecture on how the ECB play’s the role of banking union by default, herding a slough of finance ministers and other hangers-on appointees to do the things a proper central bank should be doing in one state with one set of aims rather than 19 with conflicting aims…. No wonder every decision goes to the wire..

Effectively the ECB solution to crisis since 2011 has been to keep European banks solvent by giving them lots of free money which they spend on buying European sovereign debt. As policy, It’s Utter Genius! The success of the policy allows us to celebrate the last 8 years of strength and security of the European banking sector and the concurrent sustainability of European sovereign debt.

Or, to put it another way – Europe and its banks are now caught in such a co-dependency cycle, the only realistic choice for the ECB is to keep doing it and for investors to keep arbitraging it. Buy European banks and buy Sovereign debt – Why? They might be locked in a deadly embrace… but its’ highly unlikely the ECB will ever let it unwind.

The simple message is buy European banks and sovereign debt… because.. er… I don’t think Compliance will let me write something like: “because its’ the most functional and successful Ponzi scheme of all time…” so I won’t. But it works… right up to the moment it doesn’t – TLTROS: European Finance’s ultimate perpetual motion machine!

Since 2011 it’s worked like this: Europe, through the ECB, staves off collapse by giving banks lots of free money to keep them solvent, and by the same move that cash can fund Europe by solving any run on the European Sovereign bonds. For example; the ECB’s gives Italian banks some Euro 250 bln in “Long-Term Repos” at zero cost. They could go and lend that money to Italian corporates to stimulate growth, jobs and the economy.. (as suggested in the QE policy guidelines), but we all know Italian banking runs on NPLs of about a gazillion percent, (I exaggerate… the number was around 14.38% in 2017 according to the World Bank – which is four times higher than any other European country). It’s therefore more efficient for everyone to recycle that free ECB money by buying Italian debt.

(In a slightly more advanced version of the same programme, European banks invest their free ECB money buying European corporate debt on the basis the ECB is also buying it – that game is now closed, but don’t bet on it not being reopened.) Simples eh? Everyone is happy – Italian banks aren’t looking as dodgy because they’re not lending to Italians, but to the Government, and their stock prices go up…

At the moment there is some Euro 722 bln in outstanding Targeted Long Term Repos (TLTROS or Free Money) given by the ECB to banks across Europe. If the ECB was reduce the spigot of free cash, then that would be tightening financial conditions – something even German bankers understand would be a bad thing for European economies stumbling into recession. If they ECB was to politely ask for the money back – it all matures by March 2021 – then goodbye European banking system. Forever.

I confidently predict someone at the ECB has already figured out the only way to shore up growth in Europe is to keep giving away yet more money to banks through TLTROs. (I am being unfair – they are already discussing it. They have no choice but to!) All I’m really wondering is how they’re going to describe it when they announce it..

Out of time and back to the day job..

Bill Blain

Shard Capital