The financial markets are increasingly acting like spoiled kids. On Thursday, March 10, the European Central Bank announced new measures aimed at boosting inflation and economic activity. Markets rallied initially, but quickly declined after hints of not getting further negative rate cuts. The fact markets are not even fazed by promises of more free money shows the situation is getting dire.
So what new monetary stimulus measures did the ECB announce? First, an additional 20 billion euros of bond purchases per month, bringing the total monthly purchases up to 80 billion from the current 60 billion. Further, the program is expected to extend into 2017, which should push the ECB balance sheet to over 3 trillion euros.
Remember the Fed tried rounds of QE that reached a similar $80 billion per month, with the same intention of lowering interest rates and trying to spur spending, credit, and growth. It was a grand experiment, which has subsequently been shown to have little benefit and may even have sown the seeds for future problems.
Second, the ECB will expand its quantitative easy program to include high-rated corporate bonds. Yes, the ECB will be purchasing company bonds; in other words, loaning money directly to private corporations with freshly printed money.
Third, a program of four-year loans will be made available to banks, with interest rates ranging between zero and -0.4%. Let that sink in for a second. The ECB is ready to literally pay other banks to borrow money, with the intent they then lend out this money into the economy.
Fourth, the deposit rate was cut into even deeper negative territory, to -0.4% from -0.3%.
The reason the markets reversed course and gave up the initial rally was due to ECB President Mario Draghi’s comments that rates will probably not go any lower. Draghi screwed up by actually telling the truth. Referring to interest rates, he said, “Does it mean that…we can can go as negative as we want without any consequences on the banking system? The answer is no.”
As we have recently covered here, there are fundamental problems with negative interest rates, such that they will never work. Draghi realizes this, but he wasn’t supposed to admit it to the markets.
All of this shows just how desperate the ECB has become, and how futile it is for monetary policy to try to create real economic growth and wealth. It seems this idea is finally dawning on some investors and economists. These measures were more than what the market was expecting, yet they had little effect. Doubts may finally be creeping in that all of the money-printing in the world cannot solve these problems.
That hasn’t stopped some pundits from rushing in to defend the ECB and explain there is plenty of ‘ammunition’ left. For example, QE could be increased in size, it could be extended past 2017, or it could even start to include buying of other financial assets like stocks and real estate. But this is just more of the same.
The ECB moves will likely weigh on the Fed, which is meeting next week. In a world where all major central banks are easing, the Fed won’t want to be the odd-one out, causing a further strengthening of the dollar and a decline in exports. Although an additional rate hike is not expected, the Fed may be pressured into hinting at halting future rate hikes, or try to talk down worries of more tightening.
Central banks are increasingly getting desperate; the latest ECB move was likened to ‘throwing the kitchen sink’ at the markets. But more printed money isn’t going to solve a structural problem, and it appears some people may finally be grasping this reality.
Chris Kuiper, CFA is currently a student and researcher at George Mason University, pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.