ANDREAS STENO LARSEN: The point is that there is no scarcity of Euros out there, but there's a scarcity of dollars so it's much more important if we get a dollar liquidity injection compared to a Euro liquidity injection. No one needs a Euro liquidity injection. No one wants the Euros.
They will probably focus on rates first but due to the liquidity issues that I mentioned in terms of dollar funding markets, I wouldn't be too surprised to see them launch a QE4 program by end of this year.
That's basically where we are now, a liquidity driven cycle. There's no real business cycle lift.
ROGER HIRST: Andreas of Nordea sends a chart through a couple of weeks ago, which was showing how QE and yields have performed over the last 10-Years and in some ways, counterintuitively, yields about to stabilize and gone up during periods when central bank I've been buying bonds, and when they stopped buying bonds, it's when those yields have been falling. In case of the bund, the German 10-Year, they've actually collapsed.
I wanted to question him in the post-ECB environment where we just seen Draghi announced QE eternity, whether Draghi has saved the European system, whether we can get growth where the banks can be rescued from the mire that they're in, or whether this is just another short term potential gain for Europe. Ultimately, is Europe stuck between a rock and a hard place where if you try and save the banks, you'll fail to save the exporters; if you save the exporters, you'll lose the banks? It seems that Europe is in a very, very bad position but is it on its own? Can anything be done or do we need help from outside of Europe such as the Fed? That's what we're going to talk to Andreas about now.
Andreas Stenor, welcome to Real Vision. I believe this is your first visit to us.
ANDREAS STENO LARSEN: It is, yeah.
ROGER HIRST: Excellent. You are the joint head of macro strategy at Nordea where I believe you're a lifer at Nordea. Can you maybe just give a little bit of background for our viewers as to where you've come from and how you got into this position in this world?
ANDREAS STENO LARSEN: Well, I consider myself like the Mr. Nordea. I've never worked for anywhere else. I've been in the macro strategy part of the business forever, at least forever in my life. I've been there since I was 20 years old. I started there as a junior, basically worked full time throughout my studies, et cetera. It's been my life to just be at macro strategy at just Nordea. It sounds a little bit boring.
ROGER HIRST: We love macro here, because it's the key thing. In fact, obviously you're here to talk exactly about that. I think this fascinating world of Europe, fascinating world of yields and this lovely chart that you've produced, which shows mainly it's the bund yield versus QE1, 2, 3 and the ECB QE plus European inflation expectations. It's quite a distinct pattern. Well, maybe you could explain that pattern, what it is and maybe why you think that's come about.
ANDREAS STENO LARSEN: The thing is that the vast bulk of the drop we've seen in long bond yields in Europe has occurred outside of QE programs. Outside of the three QE programs from the Fed and outside of the program from the ECB. The interesting thing is that we've actually had this pattern that bond yields tend to pick up while central banks are purchasing bonds. It's actually counterintuitive.
I think the reason is that central banks have managed to artificially push up inflation expectation, growth expectations, while purchasing. Counterintuitively, while they purchase bonds, they push yields higher. It makes sense from a Friedman perspective, but it doesn't make sense from a supply/demand perspective, I guess.
ROGER HIRST: I suppose it could be because the world was so well and truly broken in 2008, that maybe bond yields would have collapsed even lower if they hadn't come in with QE and QE creates the illusion of growth, because it's very, very minimal growth. When they start, the emperor has no clothes. They stopped doing an ego, actually, you know what? There is no growth and maybe those yields collapsed with it at the same time.
ANDREAS STENO LARSEN: Yeah. I feel pretty sure that 10-Year Treasury yields, they would have gone to zero if the Fed didn't start the QE program after the Great Financial Crisis. They saved the bond market in a sense and it's interesting that they've actually managed to do that exact same thing each of the three times they've conducted QE. That's also why I have the view right now, if you want to bet on the curve steepener, then you need to wait for the Fed to launch QE4. That's it.
ROGER HIRST: Here we are, sitting on a Friday after the ECB launched QE eternity, forever and ever, do you think that that in itself is going to help bund yields because bund yields obviously recently hit minus 75? They've recovered quite early to minus 50, on the minus 50 now, do you think that QE eternity is going to be sufficient to properly lift bund yields and properly lift inflation expectations?
ANDREAS STENO LARSEN: Probably not. If we look to Japan, it hasn't really been a success with QE eternity. I'm not an optimist on behalf of the Eurozone in that regards. I would be much more optimistic if it was the Fed that launched a new QE program. The point is that there is no scarcity of Euros out there but there's a scarcity of dollars. It's much more important if we get a dollar liquidity injection compared to a Euro liquidity injection. No one needs a Euro liquidity injection. No one wants the Euros.
ROGER HIRST: What is the issue-- we constantly hear this that the Eurodollar market is tight, there is this dollar funding issue, there are fewer dollars in the system because the US is no longer importing as much oil, global growth maybe has peaked and global trade maybe has peaked, and obviously, the corporate in the US broke quite a few dollars back with those tax changes. Is there an issue around funding at the moment in this Eurodollar market? Is there a problem with the dollars?
ANDREAS STENO LARSEN: I think there is a growing problem and it will probably emerge as an even bigger problem three months from now. We know that the US Treasury will withdraw further dollars from the commercial banking system as they will pile up the Treasury counter at the Fed again. That's an important thing to watch over the next three months, because they will basically take out dollars when they pile up their own cash account at the Fed again.
ROGER HIRST: Can you explain that down, this has to do with the debt ceiling?
ANDREAS STENO LARSEN: Yes, exactly. When the debt ceiling was suspended, the Treasury basically allowed itself to issue again. Before that, they had taken the cash account all the way down to zero more or less. They are not allowed to hold a lot of liquidity ahead of a debt ceiling deadline, simply due to the fact that they don't want to give politicians too good incentives to just drag out the discussion forever.
Once we on the other side of this debt ceiling suspension deal, the US Treasury can issue bills again at a higher pace, and then rebuild this cash flow at the Fed. When they do so, they take that exact amount of liquidity back from the commercial banking system. That's an issue for funding markets I would say.
ROGER HIRST: Where do we see that most acutely? What should people be looking at? I was looking at things like FRA/OIS. Is that this is the Fed rate agreement versus the Overnight Interest-- Is that a good place for it? Because it's breaking out but it's still quite low compared to the last two peaks.
ANDREAS STENO LARSEN: Yeah, that's definitely the one who watch, the dollar Libor OIS and it is priced to get high over the next 3 months. I would also watch out for risk appetite in general. If funding becomes a problem in general, then you could see spillovers to credit space, you could spillovers to equity space, basically. This is a matter of risk appetite as well.
ROGER HIRST: Bringing that round because in this world where we're so interconnected, we look at, oh, this funding issues over there, there's this dollar over here, there's this bund yields falling. All this actually is this is quite dangerous and toxic environment for European banks as a whole. We've always talked about yield curve flattening and yields being depressed being bad for earnings. We've had this incredible collapse in bund yields and a flattening of the yield curve in an environment where yes, growth has been a problem particularly for Germany, but we're not in a crisis mode now.
Do you see that this funding is going to be an issue for European banks? Are European banks struggling to get enough dollars?
ANDREAS STENO LARSEN: It could be an issue for European banks, but I would expect European banks to struggle more due to the flat yield curve in Europe, basically. I would have said, after the ECB meeting yesterday that it was a success if they managed to steepen the yield curve, they did not. Actually, the opposite happened, they flattened it due to a very, very poorly designed tearing system, in my view. Actually, they only did matters worse for the European banks. The struggles will continue, in my view, given that the yield curve did nothing but flattening yesterday.
ROGER HIRST: The tearing, what was the tearing they announced or how's that going to work for these banks?
ANDREAS STENO LARSEN: Well, they announced an exemption for all banks in the Eurozone six times their marginal reserve requirement. That's basically the buffer that a bank needs to hold at the ECB. Six times that amount will be exempted from the negative deposit rate at the ECB. The issue is that all of the deposits, they are parked in German, French, Dutch and Finnish banks.
When Italian banks are exempted six times their marginal reserve requirements, they basically allow the Italian banks to place all of their excess liquidity at zero at the ECB because they don't have a lot of excess liquidity. That could lead to a spike in rapid rates in Southern Europe. Maybe there is actually a risk of an unintentional tightening of financial conditions in Southern Europe due to this tearing system. One size doesn't fit all in the Eurozone.
ROGER HIRST: If we're looking for risks in Europe, I think you and myself included, I've been focused on the German manufacturing slowdown based on China, et cetera. Do you see the greater risk here actually still being the peripheral? Is it, well, that the Mediterranean countries and their banking system, or is this now endemic across the whole thing? Everyone's got these massive lots of liabilities, but they're not getting any income. Is this the whole of Europe, or is it still we got to focus on Italy and places like that?
ANDREAS STENO LARSEN: It's upside down now. I think Germany is quite clearly in a recession at the moment. Sweden is in a recession. The manufacturing countries are in a recession. It's pretty much upside down compared to 2011, 2012. The issue is that a lot of the Southern European economies, they are so interlinked into the German economy that I would expect German woes to spill over to Southern Europe with the time lag. We are yet to see that in a big scale but I think Southern Europe is next up in this slowdown. It's inevitable.
ROGER HIRST: Focusing on Germany, do you Germany's slowdown as-- I think we've had four or five months now where its manufacturing PMI has been sub-45, so in that recessionary territory. Do you feel that there is still more potential downside or do you think that there are-- I heard they say green shoots, but it might be a bottoming out in that peak fear of German manufacturing? How do you see Germany in this?
ANDREAS STENO LARSEN: We talked about green shoots for I think it was one month during the spring, and it was just shut down almost immediately by Trump. I think if we look at German figures, I would expect them to bottom out maybe during the first half of next year. I would actually have expected them to bottom out already. This is what makes me a little bit scared.
If you look at the stimulus from low interest rates, a weaker Euro, you should have expected that stimulus to get things going in Europe. Maybe rates are not low enough. The concept of a neutral rate. The rate that is neutral to the economic momentum of an economy. If rates were currently low enough to really spark momentum in the German economy, why aren't we seeing it? Maybe we need to get even lower before we really see a pickup in momentum. I'm not an optimist on the German economy's behalf, at least not for the next six months.
ROGER HIRST: Rock and a hard place because the transmission mechanism for growth has generally been the banking system. That's obviously slowing down or having problems because of the yield curve. Europe is an exporting block, therefore getting the Euro lower. They want to get the Euro lower, I'm guessing, but without being seen to obviously get the Euro lower, which is pretty hard to do. Get the Euro lower, which helps exporters, but in the things that get the Euro lower often will be things that flatten the yield curve and maybe even dampen yield, which means the banks get screwed. Which one should they really focus on and can they? Is this the problem of Europe? Is that damned if you do, damned if you don't?
ANDREAS STENO LARSEN: Yeah, it is. I would actually-- if I were a member of the ECB, I would do my utmost to try and resteepen the European yield curve to help out the banking sector again. That would be good news for the Euro, as you say, and so I'm not in a position where I would be scared of a slightly stronger Euro. If you actually managed to resteepen the yield curve, I think that would be better news for the Eurozone as a whole compared to the situation we're stuck in right now.
ROGER HIRST: What would be the impact of that on the Italian banks? Everyone worries that if yields go higher, then all the indebted, particularly the Italian banks, et cetera, they can't withstand that expectation. We had that little fear factor at the beginning of 2018 and Italy, I think currently, their 10-Year yields are sub-100 basis points. They haven't quite taken to Germany yet as they had a couple years ago. If you want that steep yield curve, doesn't that then become a problem for the sovereign, or is there a buffer where you say 2.50% is where it becomes a problem?
ANDREAS STENO LARSEN: You can try and steepen the yield curve from the front by bringing the front even lower than what we see right now. I think that's in the plans of Christine Lagarde, the next ECB President, to take the front much, much lower than what we see now. I wouldn't be surprised to see the policy rate below minus 1%. That would be her toolkit to get the steeper yield curve. It's not necessarily a problem in the long end, you need to steepen the yield curve from the front end in my view.
ROGER HIRST: With Christine Lagarde, the expectation is she's going to bring the fiscal side of it as well. Is there anything out there, which like you said, that going to minus 100 is a good idea, it seems to me that these people, they say, "Well, the reason why this hasn't worked so far as we haven't done it in enough size or we haven't been aggressive enough. It's failed, because what we need to be is minus 100, we need to do more--" What are they basing their views on?
ANDREAS STENO LARSEN: I think the ECB is fighting itself in a sense, given that they impose more and more regulation on banks in the Eurozone, while they try to force the credit cycle up and running again via the monetary policy tools. They're fighting against themselves. On one hand, they try to limit the activity via regulation, or I don't know whether they directly tried to limit the activity, but they do via the regulation. On the other hand, they tried to force the credit cycle back up again via the monetary policy tools. In a sense, they're fighting against themselves. If they actually allowed both channels to work with the Eurozone momentum, then I think we could get out of this mess.
ROGER HIRST: What timeframe would that be? Because obviously, as investors, people think, "Well, okay, when do I want to go long banks?" Banks having a nice bounce as we speak the day after the ECB, but we've seen bounces before, they don't have any lags. We've seed your backup in yields and the peter out just when we get excited by them. Everyone's waiting for this move. What's the timeframe? How long can we visit this? Because these tend to last for no more than 6 months when we get a really good bounce.
ANDREAS STENO LARSEN: Yeah, I wouldn't go really long banks in my portfolio unless the Fed joined the QE party. I think that's much more important for the reflationary environment if the Fed launched QE4 again, so I think it's only a short term story if anything. This QE story from the ECB, I don't think it's a lasting story at all.
ROGER HIRST: The Fed's not going to do QE anytime soon, they're going to focus on rates first.
ANDREAS STENO LARSEN: They will probably focus on rates first but due to the liquidity issues that I mentioned in terms of dollar funding markets, I wouldn't be too surprised to see them launch a QE4 program by the end of this year. I know it's not the consensus rule by now but I think they will simply have to add some dollar liquidity to the market in one way or the other. I think the easiest way to communicate it is just to launch a soft QE4. Why not?
ROGER HIRST: That QE will be commensurate with that drawdown with the Treasury, from the markets of the Treasury funding, and they go, "Okay, well, we're putting 250 billion down or whatever the number is, we need QE at least at that size." What have you seen in things like velocity because whenever people do QE, you do the balance sheet one way and velocity is the other way. Actually, when the balance sheet of the combined bank started to roll over, as we got 18 months ago, velocity started to try and pick up but if they go back to QE, doesn't that just mean velocity falls, which means that negative productivity, negative growth prospects, so actually we're just hammering another nail in the coffin of low growth?
ANDREAS STENO LARSEN: Yeah, it probably will mean that but I think there are different time horizons in this story. The first time horizon is the positive reflationary story, the artificial buildup of expectations again. It's more a buildup of expectations than the actual reflection. If they launched this soft QE4, I think we will see a buildup of expectations, but I don't think it will materialize down the road. That's the difference in time horizons. First move, up. First move