The ECB – for real?

March 18, 2021

3:05 pm

The ECB – for real?
  • In terms of all-time great press conference disruptions, that Iraqi bloke throwing his shoe at George W Bush back in 2003 is hard to beat. A 4.5-star rating goes to the glitter bombing of Mario Draghi at an ECB presser back in 2012 (photo below courtesy of CITY A.M.). Given the dour times in which we live, it was probably to be expected that ECB President Lagarde admonished Greenpeace activists for landing a paraglider on the roof of the ECB’s Frankfurt headquarters ahead of the meeting on the 12th March as part of an ESG-related protest. Madame Lagarde insinuated that landing on the roof was a Covid-19 health risk. Really?
Source: CITY AM.
  • The low-octane ‘revelation’ from the previous ECB meeting was that the pandemic emergency protection programme (PEPP) ‘envelope’ of €1.85tn may not be fully utilised if it is not needed. Yet at almost every opportunity since then, ECB board members have been talking up intervention and bond buying in almost complete contradiction to the official policy stance at the meeting. The proximate cause has been a rise in global bond yields. Long gone are the days when rising yields were a mark of reflation, recovery and normalisation – now they are a threat to solvency due to the massive stock of debt outstanding. If one were to need an accurate assessment of the extraordinarily odd place the global economy currently finds itself, then this is it.

  • ECB board member and dove-in-chief Fabio Panetta took up an apparently new and more radical policy stance in a speech delivered at Bocconi University on the 2nd March while talking on the subject of recovery from the pandemic. Mr Panetta explained how inflation expectations, despite a likely short-term spike, would remain low, that investment would remain subdued, and that the recovery would be slow and uncertain. It was therefore beholden on the Central Bank to act more aggressively.

  • In the main thrust of the speech, Mr Panetta seemed to be making the case for yield-curve control. Quote:
“We have now entered a third phase, in which we need to preserve accommodative financing conditions to support the recovery and the convergence of inflation to our aim. This essentially means more focus on anchoring key financial variables – above all, lending rates and the yield curve – as key indicators of the monetary policy stance. This approach should progressively add accommodation because, as actual and expected inflation pick up, anchoring nominal yields allows real yields to fall. And there should be no doubt that lower real yields would provide welcome additional stimulus, given how far we are from full capacity and the subdued level of current and expected inflation.”
  • Mr Panetta went on to say, “My main message today can be summed up with the title of a song by the electronic music duo Daft Punk: “Harder, better, faster, stronger.” RIP Daft Punk, but quite what a couple of French DJ’s famous for their big, shiny helmets has to do with monetary policy is anyone’s guess. Are these guys for real?

  • Yield-curve control (YCC) commits central banks to maintaining the nominal yield on bonds at various parts of the curve at pre-determined levels through open-market purchase operations. Some central banks are doing this already – the Reserve Bank of Australia (RBA) has a 0.10% target on the 3yr bond, while the Bank of Japan (BoJ) has a 0% target on the 10yr with a plus or minus 20bps range. The Fed has floated the idea as well, although it seems to be a long way from being policy right now.

  • This would be a radical move from the ECB. The aim would be to drive down real interest rates, allowing government and corporate borrowing at favourable levels to effect a recovery. If this meant higher debt levels, one might expect the euro to weaken against the dollar as a result. While the RBA and BoJ can just go ahead and implement such a policy, the ECB as a supra-national central bank has a host of national political interests to accommodate, not least reticence from Germany and the ‘frugal four’ to further commit to extraordinary monetary policy to help European countries in need (think Italy and chums). There is of course the legal issue of the ECB aiding deficit financing in contravention of the Lisbon Treaty, but given this is Europe, we all know rules are there just to be set aside when the situation demands it.

  • Mr Panetta’s speech thus teed-up the March ECB meeting with potentially high expectations not only of a YCC announcement, but potentially Madame Lagarde also telling us what bond yield levels would be suitable. On this front, the meeting was a disappointment – when asked, Madame Lagarde said there is no YCC coming, nor any target rates. Perhaps this will be a back-door policy implemented incrementally and under the guise of a necessary action in the face of what is likely to be another crisis at some point. One expects there might at least be some pushback from Germany et al anyhow. As ever, the official press conference ECB sounded much less dovish than the intra-meeting musings of the (non-German) board members.

  • What Madame Lagarde did announce was an increase in PEPP purchases for the next quarter. The size of the ‘envelope’ will remain the same, but the pace of buying will be more vigorous. Perhaps this means €25bn per month up from the recent €12-13bn per month, but she was particularly unclear about how the buying would happen, and what the vectors were that would it on a day-to-day level. Her explanation descended into an almost incomprehensible jibber-jabber of terms like ‘holistic’, ‘multi-faceted’, ‘upstream-and-downstream’ and so on, a master class in obfuscation.

  • The announcement though had an immediate effect on the bond market, as can be seen from the graph below of the 10yr Italian BTPS yield. While the short-covering rally was impressive, the market did start to give back its gains when it realised that the overall PEPP was no bigger, and therefore counts as another example of the ECB triumphing in style but not in substance. With US treasury yields again rising on the 12th and 13th March, the question remains whether the ECB is doing enough right now to achieve its policy goals if yields on the other side of the Atlantic continue to rise.
Source: Bloomberg March 2021. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.
  • As ever, the nitty-gritty came out after the ECB meeting and press conference. Reuters headlines republished on Bloomberg alluded to a familiar story of wavering, dissent and compromise, as can be seen below:





  • On other policy matters, the ECB increased their inflation estimate for 2021 (from 1.0% to 1.5%) and 2022 (from 1.1% to 1.2%). But with Italian cities like Rome and Milan re-entering lockdown, and with the European Commission continuing to hide behind accusations of vaccine nationalism as a means of deferring criticism from its own abominable failures to procure a timely supply of vaccines, the risk of another pandemic-related fall in economic activity and therefore further deflationary pressure are extant.

  • Economics and markets are to an extent an exercise in the relative (the dollar goes up only if the euro goes down and so on), and it is in Madame Lagarde’s comments on US fiscal policy that Europe’s real problems become more obvious. Understandably, the ECB hadn’t factored in the most recent $1.9tn US stimulus into their current inflation or growth calculations since the measures only passed from Congress to the White House for approval on the day of the ECB press conference.

  • Yet Madame Lagarde’s bigging-up Europe’s own pandemic fiscal response could not avoid laying bare the gulf in magnitude between what the US is doing and what is being done at an EU-level in terms of pandemic-relief spending. The US is pushing through $1.9tn of spending at present, and this follows both the $0.9tr Covid-19 Relief Act back in December 2020 as well as the $1.8tn from the original CARES Act earlier in the year. There is speculation that Biden’s infrastructure bill, due in the fall, could be as large as $3tn (albeit spread over four years).

  • The EU’s €750m spending package does of course have to be taken in the context of the fiscal support already provided by individual EU member states within their own countries, but it is clearly not in the same league as what the US is doing. Madame Lagarde said there was a “bit of a time lag” in implementation between the EU and the US, and then implied this was somehow part of the policy (remember Hungary holding up the whole process during December?).

  • Longer lockdowns due to a failed vaccine policy and a weak recovery from a delayed and underwhelming EU-level fiscal response cannot be hidden forever behind fancy words or ugly bait-and-switch policies such as the one the EC is currently attempting with respect to Britain. One hopes that the Bloomberg headline “*LAGARDE: EU STIMULUS WILL LAG U.S. SUPPORT BECAUSE OF DESIGN” doesn’t come back to haunt her at some stage.

  • This is the real question at present – Fabio Panetta can talk about yield-curve control, but policies of this nature are transformational in terms of the reality of burden sharing, deficit financing, tax raising and so on, all of which have been key areas of conflict between EU member states for decades. If the ECB can just declare that YCC is a go, then so be it. But talking the talk and then coming up short will only ever set the Europe up for crisis as eventually the market will test the ECB’s resolve. Mario Draghi got away with just having to say ‘whatever it takes’. Christine Lagarde may well find herself in the unenviable position of having to act this doctrine out, and it is at that point that the ECB’s political and structural weaknesses will be tested out. May be Mr Panetta will be playing Daft Punk’s ‘Human after all’ at that point.
Unless otherwise stated, all opinions within this document are those of the RWC Diversified Return Investment Team, as at 18 March 2021.
In case you missed it…

The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.

RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.

This document is directed only at professional, institutional, wholesale or qualified investors. The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.

This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, accounting or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, security, commodity, financial instrument or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party.

RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.

Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of investments can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated. Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer.

The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates.

Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient.

AIFMD and Distribution in the European Economic Area (“EEA”)

The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.

In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor).

Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in Switzerland

The representative and paying agent of the RWC-managed funds in Switzerland (the “Representative in Switzerland”) is Société Générale, Paris, Zurich Branch, Talacker 50,

P.O. Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland.

Ready to start talking?