Last week, I discussed the “new abnormal” when it comes to global monetary policy – the lowering of central bank interest rates to negative levels.
Or, to give it a catchier name… NIRP (negative interest rate policies).
As I said, “The move to NIRP shows how desperate policy makers are becoming in their quest to stimulate economic growth. But to date, NIRP has produced few tangible benefits.”
So the European Central Bank’s recent unveiling of (yet more) stimulus measures for the eurozone economy was a real eye-opener.
First, the ECB expanded the amount of quantitative easing from €60 billion to €80 billion a month. The bank also said it was lowering its main refinancing rate to 0% and its deposit rate further negative to -0.4%.
ECB President Mario Draghi added that he didn’t think those rates would need to be lowered again.
Famous last words!
To make such a statement was surprising, but it was the two other parts of the ECB’s stimulus package that really caught my eye.
It seems that Draghi and the ECB have grasped the concept that using negative rates as your main monetary tool is bad.
Can we get a “hallelujah”?
The effect of negative rates on the European banking system was starting to hit home, affecting banks adversely.
So the ECB extended the banking system a lifeline. It came in the form of targeted longer-term refinancing operations (TLTROs). The first TLTRO is scheduled for a June launch.
This measure allows Europe’s banks to borrow from the ECB at a rate as low as -0.4%.
The theory goes something like this…
Banks lend the money to businesses and consumers across the continent in order to stimulate economic growth.
The more the banks lend out, the lower the rate will be. So if you’re a bank and grow your non-mortgage lending portfolio by 2.5%, by January 2018, the interest rate paid on that borrowed money drops to -0.4%.
In other words, the ECB will pay European banks to lend money!
You can see the thinking here. Troubled European banks have been reluctant to lend – a reluctance that’s stifled economic growth.
So common sense would dictate that banks will take advantage of the ECB’s free money and begin to lend more readily. Estimates are that TLTROs will add at least €3 billion to European banks’ annual earnings.
But it’s the ECB’s next move that I think is a real game-changer for financial markets…
The ECB Goes Corporate
As part of the bank’s QE program, it will now begin to buy non-financial corporate bonds.
The ECB said it will buy “investment-grade euro-denominated bonds” issued by European companies in the eurozone.
This will give a huge boost to both European companies and the European corporate bond market. Why?
Because corporate bonds will have a big, steady buyer later this year. This will obviously boost bond prices, thus lowering yields. And it should translate to European companies being able to borrow money at cheaper rates.
It will be interesting to see how the Invesco PowerShares International Corporate Bond ETF (PICB) fares. It has about half of its portfolio in European bonds.
The ECB move should be a positive for U.S. corporate bonds, too. As yields fall in Europe, investors looking for higher yields will come searching for them in the United States.
The Stock Market Effect
It’s this ECB move to buy corporate bonds that I believe is behind the U.S. stock market’s latest move higher.
After all, we’re now just a short hop, skip, and a jump away from central banks buying blue-chip stocks outright.
Heck, the Bank of Japan already buys Japanese REITs. And the Swiss National Bank’s balance sheet already looks more like one of a U.S. mutual fund than a central bank, given all the U.S. blue-chip stocks it owns.
I’m sure at least some on Wall Street are already rubbing their greedy hands in anticipation of heavy central banks’ buying of stocks.
And if you think that’s a crazy notion, just look at the lengths that banks have gone to so far!
I firmly believe there is no end to central bankers’ experimentation in order to try to jump-start global economies. And if stock market conditions go south rapidly, this new form of QE could be in play.
Currently, the Federal Reserve is prohibited from buying stocks by the Federal Reserve Act. But an amendment in 2010 – Section 13 (3) – allows the Fed to lend money to entities to buy stocks. In fact, some have said the Fed loaned money to the Swiss National Bank to buy its portfolio of stocks.
Now, I doubt that’s true. But the ECB’s move has pushed us further down the slippery slope toward more and more direct central bank intervention in financial markets. As if we needed any more!
If stock-buying comes to pass, what’s next? Helicopter money?