Thursday, May 29, 2014

Stepping on the Monetary Accelerator and Regulatory Brakes (excerpt)

Expectations that the ECB will provide more monetary stimulus next Thursday continue to push bond yields lower in the Eurozone. That’s been pushing US bond yields down as well, especially since ECB President Mario Draghi has said he will do whatever it takes to weaken the euro. That’s made US government bond yields especially attractive relative to yields available on comparable bonds in the Eurozone.

Draghi hopes to boost the region’s CPI inflation rate, which is only 0.7%, by weakening the euro. I’m not convinced that doing so will boost inflation in the Eurozone. The problem is that the region’s banks aren’t lending, which is also depressing monetary growth. Here’s the most recent key developments:

(1) Slow money. M2 growth was only 2.0% y/y during April. That’s down from a recent peak of 4.8% last April, and the lowest since December 2011. The recent slowdown coincides with the decline in the CPI inflation rate.

(2) Weak lending. Banks are starting to lend in the Eurozone, but to each other rather than to nonfinancial businesses. Over the past three months through April, Eurozone lenders provided a measly €13.6 billion (saar) in credit, with €142.8 billion extended mostly to financial institutions. Lending to nonfinancial corporations declined by €169.6 billion over this same period.

(3) Bad loans. The 5/13 FT reported that, according to Fitch, bad loans at Europe’s banks rose 8.1% in 2013 to slightly more than €1 trillion compared with the year before. Fitch surveyed a hundred banks due to be assessed by the European Banking Authority. Twenty-nine saw the number of impaired loans rise by more than 20% as their asset quality deteriorated, while one-third of banks saw their bad loan volumes fall or stay the same. European regulators are preparing a strict classification system, which should eliminate national differences over what constitutes a problem loan.

So European monetary and banking authorities are stepping on the monetary accelerator and the regulatory brakes at the same time. They are providing ultra-easy monetary policy hoping that banks will increase their lending. At the same time, they are toughening loan standards and subjecting the banks to stress tests. As a result, they are driving global bond yields into the ditch.

Today's Morning Briefing: Dancing With the Bull. (1) Morphing from cyclical to secular. (2) Bull market in earnings. (3) 50% jump in P/E since 2011. (4) Secular bull’s favorite sectors mostly the same as the ones during cyclical bull. (5) Eurozone yields driving US yields lower. (6) Will weaker euro boost Eurozone CPI inflation? (7) Draghi blows off Krugman. (8) Eurozone’s problem is lack of bank lending and weak monetary growth. (9) Stepping on the monetary accelerator and the regulatory brakes. (More for subscribers.)

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