When Monetary Policy Isn’t Enough
The Expert View
Featuring Christophe Ollari
Published on: September 17th, 2019 • Duration: 29 minutesChristophe Ollari, founder of Ollari Consulting, predicts that we have seen the peak of monetary easing for this cycle. In its place, Ollari argues that policy will tilt toward a new sort of “Social QE” - involving central banks and governments in Europe, Japan, and the U.S. acting in concert. Ollari explains the political ramifications of this shift in policy, and speaks to what it means for markets. Filmed on September 13, 2019 in London. Learn more about Macro Insiders here: http://www.realvision.com/macro-insiders
CHRISTOPHE OLLARI: There is a fracture within the ECB.
What happened when Draghi leave? Is there a life beyond Draghi? Like is there life beyond Merkel?
I think that for 2019, unless the macro outlook deteriorates much further, I think we have seen the end of the easing wave of the central banks.
There is global need from voters to get the bigger share of the pie.
Even if they don't want to call it social QE, they are calling for that. They want to move away from the financial QE into a social QE.
I'm Christophe Ollari and I designed a few years ago a global macro, multi-currency, multi-asset research, and this after roughly 20 years of trading in banks and hedge fund.
What should we make of the ECB's latest moves?
I think that just even before I'm looking at the details of the ECB package, I think what is very important, it's a year ago, the ECB announced the end of their QE program. We are one year later and we are just about to see the resumption of the ABP. It just shows how much the global macro and the European outlook has deteriorated in 12 months. I think it's a very strong message. The objective was to start some normalization and we are exactly back to where we were a year ago.
About the package, I think that there's two ways to look at it. It's very high expectations in mid-August after some comments of ECB member where the market is starting to price an extremely aggressive package. Compared to what was priced in three weeks ago, it was some extent disappointing but we had over the last 10 days all the ECB hawks on the White House and I think that market repriced their expectations and compared to the expectations prior the meeting, I think we are roughly in line because we had the 10 bps cut and the markets were pricing 16 just ahead of the meeting. We had 20 billion of asset purchase. I think that market was expecting between 20 and 25 so it's roughly in line and we had the tearing plus the more advantageous shareholder terms.
I would say that the package need said is good. The big difference is I think that-- and I mentioned it in the last few days, it's the key focus was on the forward right guidance and I think that in total, that part was extremely dovish, because not only the end of the QE program plus any hike will be contingent to inflation back to target the 2%, but staying anchored around 2% for a sustainable period of time, which is quite a very aggressive way to say you know what, our accommodation will remain in place for quite a lot of time, especially considering that they revised lower the inflation forecast, especially for 2020, which has been revised down from 1.4% to 1% and for 2021, we're at 1.5%.
You can assume that according to their projections, we're going to have QE for two years. This is the good part. Then you can assume that to some extent, they'll open the books but when you look at in the details, there are some early questions and I'm wondering to some extent if it's not the bulk of our books. Why? Because first of all, we learned very quickly that there was no consensus and you can already see that dissenters are becoming vocal. This morning, ECB member not acknowledge that there's no need for QE, there was no need for such a legacy package and that the European outlook was not in a state requiring such an aggressive accommodation.
I think it was quite surprising for me to see that influential members like Coeure-- Benoit Coeure join the anti-QE camp. Then we have that question asked yesterday to Draghi, asking if they discussed about the change of [inaudible] and he mentioned that they didn't, which in itself not to be a problem because we are still a year away from the end of the collateral but it means that what looks QE infinity will be questioned relatively soon by the old members saying why should we extend? We don't have any more pool.
You see that there is a fracture within the ECB and maybe the bottom line up yesterday was it was not the ECB package, maybe it was more like a Draghi package. Or it was not an ECB package, it was a peripheric member package. The issue is, the question is, we had Draghi for so many years and he put his print on the ECB monetary policy. What happened when Draghi leave? Is there a life beyond Draghi? Like is there life beyond Merkel? In fact, it's more question marks about what's going to happen when Draghi leaves, and when Lagarde will step in?
In fact, it's a way to limit the-- in fact to limit, for each country, the amount of bonds you can buy and the question will be if there is no more collateral available, that we need to push it to 50% to be able to buy more government bonds and especially from Germany.
How effective will the new ECB policy be?
To a certain extent, I agree with the comments this morning, it's they are unlikely to achieve much. If we can learn something from the last four years, it's in terms of real inflation, in terms of real GDP, QE and negative interest rates didn't achieve much. I think that what they are trying to do is something very important. It's keeping very loose financial conditions and secondly, I think that the idea underneath is to keep all the term structure of the European bonds as low as possible to give very easy funding conditions for the European governments.
I think it's more like okay, it's a bridge between the military policy and the fiscal policy to incentivize the governments to push on the fiscal expansion [inaudible]. I think we reach the-- at least properly, we reached the peak of stress and pricing of the Armageddon scenario in mid-August. As far as I'm concerned, I think that we've seen the lows in yield, especially in Europe. From now on, I don't see much interest or focus on those nominal curves and I think that by telling everyone rates are going to stay low for a prolonged period of time, and that we're going to do QE for the foreseeable future, it becomes more like a carry threat and I imagine that there will be a lot of interest on banking credit, for example, where you see can pick up some carry.
My view is that the big move has happened already on the European yield and I don't see more juice down. I think that Europe is quite worrying global-- it's got quite a worrying global outlook compared to 2017. Today, we see that GDP has more than helped, inflation has more than helped as well and everybody's trying to explain that one of the key catalyst for the deterioration of the European outlook is in fact, the trade war between the US and China. Again, we tend to forget that the reversal of the European growth didn't happen in 2018, but happened at the end of 2017, which was in fact, the consequence of the change of old model growth by Beijing early 2017 and you have the usual transmission mechanism between China on one side, and its carry growth, and the very open economies starting with Germany and Europe.
In fact, the European malaise started well before the trade war. It started early 2017 which means that the fate of European growth is not in Frankfurt, is not in the hands of the ECB. I think the fate of the European growth, as usual, will be in Beijing and its ability and willingness to shift again into an old growth model, it will be dictated by Washington and the US administration willingness to pause the trade conflict or not. I think it will be dictated essentially by Berlin, and the ability and willingness from Berlin and the German government to finally put into cover their obsolete fiscal rectitude.
How does Japanese policy compare to Europe?
It's just like a very quick word on the BOJ. I think that what happened on the ECB side has no implication at all on the BOJ. I think the BOJ has made clear that-- [inaudible] has been clear that they were very focused on the exchange rate. We know that the breakeven level for the Japanese export are about one to seven so at 120, I don't think that the BOJ is in any urge to do anything. Also, last week, we had the Japan military base, the expansion, and we went down to 2.3%, which I think is nobody talked a lot about it, which is very worrying, because we are exactly back to the level pre-QE.
In fact, it just mean that they have increased the balance sheet of 200% of their GDP. They have injected trillions of liquidity. The liquidity didn't-- the cash didn't go anywhere. I think that the BOJ has already reached limits of their monetary policy impulse. When Draghi said-- well, he insisted on the need of fiscal expansion in Europe and I think it was a clear acknowledgement that in Europe as well, the military policy stimulus has reached its limits already. Again, preserving the loose financial conditions, giving the conditions for the governments to use their budget surplus and implement proper fiscal expansion but it's not going to change anything for inflation and growth in Europe.
What's your view on US monetary policy?
I still think that the Fed's going to do 25. It's very rare to see a 100% cut or a 95% cut a few days before the FOMC and the FOMC decided not to deliver. The question is not on Wednesday, the question is okay, what next? My guess is the Fed is still not ready to do much more and I think it's going to be very contingent to the data. I insisted a lot in the past and the fact that the Fed has been already corrupted by the political sphere and you can see that if the ECB has shown some fracture yesterday, and in the previous days, the Fed is fractured as well and there is dissenters who are not ready to just to potentially-- even if they don't talk about it, to give a free ride to talk of the elections and I think that there is a very strong political aspect in the FOMC.
Now, they're going to do 25 and I think that there is this very at best neutral message. The hawks at the Fed, they can just keep on repeating unemployment rate at 3.7%, growth around 2%. Inflation, they're not going to use their-- or they're going to use the CPI saying we are back to 2.4%. Average earnings at 3.2%. I think that the Feds today were again on the strong side. I think you're going to have dissenters and you're going to have-- people would question, "Do we need to do much more than another 25?"
Where's monetary policy headed after 2019?
We have reached a very important point yesterday and/or tomorrow or next Wednesday. It's I think that for 2019, unless the macro outlook deteriorates much further, I think we have seen the end of the easing wave of the central banks. We had a lot of impulse given by the EM banks, central banks, I think that the ECB is done for now unless you have a chromatic deterioration, and I think the Fed will do 25 and maybe just not wait and see, but data dependent. We have reached that big wave of impulse.
In that context, I think it's very difficult to see the dollar dramatically collapse, or correct. It's only if you have slowly but surely an inflection of the data, which is so far too early to predict. Again, and we'll go back to Draghi, because yesterday he said something that I thought was very interesting. He said that one of the first task of Lagarde and in some brainstorming project will be to question the relevance of the inflation target. Personally, I don't think that it's relevant anymore because in fact, what is the point to have an inflation target at 2% when you undershoot all the time, and you can never reverse a psychological effect. You can see it in Japan, people know that 2% will never be reached so it's like an illusion.
The problem is, what do you put instead? You put 1% to be sure that you are fulfilling your mandate. This is an illusion as well, or do you put 4% just to show people that to create some inflationary momentum, I doubt it would work neither. I think that the inflation target is illusionary and obsolete but I still don't know, to be honest, with the current monetary policy framework, we can reach those targets. I think the answer is maybe in the ability to create new economic approach, which will in time potentially boost the real inflation and not only inflate our financial assets.
How will monetary policy and politics intersect going forward?
I think that this will be the debate of the next few years. I am massively convinced that QE, low interest rates have only been a strong catalyst to boost financial assets. What has the ECB done yesterday is another episode of financial QE. Financial QE will not bring anything except it maybe fuel even more the anger and the resentment towards the elites, towards the central banks, toward the banking system in general. I know that MMT has become a big subject and attract a lot of stigma, is a Ponzi scheme. It's a scam.
I believe that it's not about do we like MMT or do we don't like MMT? I think that it's more like the concern in what is underneath which is important. What is important is there is a global need from voters to get the bigger share of the pie and the pie tend to reduce. It's all about redistribution. I think that political candidates will integrate some bout of MMT which in fact, already exist. What Donald Trump is asking for? He's asking for spending and the Fed resuming QE to basically transfer the public debt which is in the banking balance sheet into a public balance sheet, the Fed balance sheet.
What is doing the BOJ and the IB? They're doing MMT to some extent, it's they put the rates at zero, everything is worth zero and they are just spending and the BOJ is funding their fiscal stimulus. Even if we don't call it MMT, it's already in place. What the ECB is telling everyone yesterday, it was like, we're going to do more QE, but you have to spend to-- even if they don't want to call it social QE, they are cutting for that. They want to move away from the financial QE into a social QE.
The only one problem is it's going to take time but I think that it's a debate, but I think, for me, this is the obvious journey we are going toward. You remember the big dream of Bernanke when he implemented the first round of QE? He was like, okay, we're going to put a lot of cash in the system, it's going to inflate equity market, for example and then those positive effects will slowly spill over into the real economy. That was a beautiful dream, it never happened. This is what I basically called financial QE. It's like, okay, we have created a gigantic financial asset bubble that in reality, accepted the 10% part of the prohibition, nobody benefited from it.
I think you have different steps in the social QE. The first step is what I think the ECB is trying to put these like, we are buying your debt, spend into infrastructure, or basically go by tax cut or income tax cut. That's the first step and I think that that first step, the central banks would be very keen to do. I think there is more extreme step where you will end up with a government and the central banks working very close together, where in fact, of the central banks will only be facilitating the spending of the government and warehouse their debt in a public balance sheet.
How will the Germans react to social QE?
The gloves between the ECB and the European governments or between ECB and Germany, I think that the message of Draghi-- in many, many years, I followed Draghi very carefully and I never saw him so adamant about the need from the countries who are in a budget surplus to finally spend and spend in size. It was pointing, obviously, the German government. I think that is good expansion in Europe is highly dependent on the ability of Germany to finally put their fiscal rectitude on the side. I think that without Germany, it's going to be very extremely difficult for Europe to have a meaningful fiscal expansion.
Is Germany ready to do it? Unfortunately, I think that it's still not there. I think that when they are talking about the ability to do something like 50 billion, if the economy goes into recession, they will be in technical recession in Q3. 50 billion is nothing and 50 billion is not enough. Does it mean as well, that if they go out of recession, they will stop their fiscal expansion? I think that it's not a structural move, that we might do it very temporarily but we're very far away from the European global broad base and sizable fiscal expansion. I think that this will be the main task of Lagarde. I still think that Germany will be extremely reluctant to go that way.
I think that is going to be in time fortunately. The problem we had for when you look at the budget deficits in Europe from 2014 until 2018, is the trend is amazing. In fact, all the European governments have deleveraged and reduced their deficits and four of them are in a surplus now. What does it mean? It mean that for four years, which is the period when in fact, Draghi started QE, they used the monetary stimulus to create fiscal austerity. There is no way that inflation could have been created, because in fact, the money which was there has been taken away on the other side.
I think that if you have a mix between monetary policy accommodation and fiscal expansion, you will finally have some maybe better chance to create real inflation. I think that the best news for Europe right now will be a rollover of the data in Germany further. I think that the more bleak the situation and the outlook for Germany look, and maybe the more the German government will be ready to finally cause [inaudible] and become a more, I would say, in sync with the real needs of the economy.
If the data imposing Germany and Europe more globally, I think that you are starting to have a big problem because the hawks at the ECB would start to be vocal, just calling for the end of QE and Germany will just very quick to acknowledge that they don't need to do any fiscal expansion. That's when you end up with this outlook for Europe which will be extremely shadow growth and undershooting inflation.
I think that the strong message from yesterday was like, it's not necessarily QE infinity, but it is a last message, "We do that but you have to do your part as well." I think that Draghi insisting on the fact that governments need to take the battle because they can't save the European economy is in fact the reality. It's they have run-- monetary policy stimulus has run its course and would be very ineffective in terms of inflation or growth if the government decide to keep on their fiscal austerity path.
Outline where we are right now on policy.
So far, 2019 has been extremely spectacular and very mind blowing. I think that we reached in August a peak of stress, a peak of Armageddon scenario which has been amplified by technical factors, and especially negative convexity edging close. We are right now on all the asset classes back on a very pivotal level and the next three months would be dictated by the ability of Beijing and President Trump to maybe pause and to bring back some wisdom that is really required after a quite [inaudible].