Apr 4, 2016

ECB Monetary Policy Decisions and the Aftershocks

In this video blog Udi Sela, VP of Business Development at Numerix discusses the European Central Bank’s most recent monetary policy decisions from the March 10th council meeting. He provides his insights on the key interest rates for the euro area, also noting the latest countries to adapt a negative interest rate strategy. Udi provides his perspective on the effectiveness of this policy, and also the impact of the asset repurchase program on market liquidity. Lastly, given that many government bonds are displaying long term maturities that are negative, Udi also discusses the implications as it relates to the proceeds of those bonds and also FX impact.

Video Transcript:

Jim: Hi Welcome to the Numerix Video Blog, I’m your host Jim Jockle. Today the continuing story on negative rates. Important note, today is Wednesday, March 23rd so a quick update.

So most recently we’ve seen the Swiss Central banks holding negative rates steady, Norway’s central bank cutting interest rates to a record low, refusing to rule out going below zero and Hungary cutting its overnight deposit rate by 15 basis points to -0.05 percent. And the ECB’s latest monetary policy changes, cut the deposit rate by 10 basis points to a historic low of -0.4 percent and stepped up the pace of quantitative easing. And finally the Reserve Bank of New Zealand recently cut it official cash rate by a quarter of a percentage point to 2.25%. Joining me to discuss the latest trends, which are continuing in this negative world, is VP of Business Development here at Numerix, Udi Sela. Udi welcome.

Udi: Thank you Jim, good to be here.

Jim: Let’s just jump in; today’s topic is clearly the Eurozone and as we continue to see countries going negative – from your perspective is this policy working?

Udi: Well it seems we’ve reached the end of a cycle in respect to it doesn’t seem to work as well as the central bankers would want. Because, basically, a few things happened. Commercial banks are still reluctant to lend money to small businesses and as a result not enough employment is being created. Inflation has been very low. This therefore it does not seem like the planned action has been that effective. The problem is   is that banks, the European banks, really need to be recapitalized just the way the US did. The biggest difference between the Fed in 2009 and the ECB is probably the fact that the ECB started much later, 2013-ish with aggressive monetary easing (e.g. QE and historically low rates).  

Jim: You bring up lending policies of the banks – not lending. We have a 900 billion Euro corporate bond market in the Eurozone at this point in time, what is the impact of this policy on those bonds?

Udi: I think it’s an interesting question because what’s happening is there are specific categories of bonds which are eligible to be bought by the ECB, and bonds that are not. So, logically, this has created a dual market where bonds that are eligible for purchase by the central bank are in demand; therefore companies that fall into this space issue debt. That’s the first thing. The second thing that we see in the market is a tremendous amount of bonds probably around 10 trillion dollars are trading negative (yields). The Swiss government bond, up to about 40 years, the yields are negative. In Japan, I think about 40% of government debt is held by the Bank of Japan – taking into account credit and others things would pose massive distortions in the market. Things begin to normalize back in the US. Interestingly, the Russian Central Bank kept rates pretty high at 11% and as a result, the US Dollar has weakened over 10% vs. the Russian Ruble. The Ruble is getting slightly more expensive.

Jim: Given that government bonds are displaying long term maturities that are negative specifically the Swiss, what is that going to mean from a borrowing perspective? Also, then what are the implications as it relates to the proceeds of those bonds? Is this the potential for government disruption in the upcoming years?

Udi: It’s difficult to answer without going into too much into politics. It does seem pretty safe to say without structural reforms, labor market etc., I believe the effect would be fairly limited. One interesting thing to note with respect to when is when (Mario) Draghi and the European Central Bank, came up with the latest police announcement, the expectations were that given the expansion…that the Euro would weaken.  And actually it was the reverse effect, where the Euro strengthened. So I think that was a very strong signal showing it’s not really working the way…weakening the local currency is the (unannounced) objective of this program.  

Jim: One other final question I want to go back you alluded to the ECB policy on the asset purchase program – clearly the market drivers are to boost market liquidity. Is it working?

Udi: No actually I don’t think its working that well. As one of things that is happening and it is coupled with increasing regulation, is that banks are moving away from market making and the positions the banks hold are smaller. As a result, liquidity has been hampered massively. And even in our company we see banks adjusting to this new regulatory environment – optimizing positions and moving out of less profitable businesses. I think in that sense there is a price we will pay for regulation and that would be low liquidity.

Jim: Udi I want to thank you so much. And clearly this is an ongoing story that we are continuing to track, monitor and talk about. I want to thank you Udi so much for your time to show some of your thoughts as these programs continue to proliferate throughout the globe. Thanks you Udi.

And of course we want to talk about the things you want to talk about so please continue to follow up on twitter @nxanalytics and stay up to date with everything that’s going on here at Numerix on LinkedIn and Numerix.com. I’m Jim Jockle thank you very much.


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