If you are the board of a Eurozone company and your central bank offers you free or better-than-free cash, of course you take it. Japan already proved that this can work back in January, when it first bought corporate bonds at a below-zero interest rate. And this new tactic of the ECB is going to affect more than just corporate bonds in Europe. US multinationals with European subsidiaries (and most have them) are going to be lining up to take advantage of a central bank that will buy up to 70% of anything the corporations issue, at rates that can’t be matched in the US. At least for now. You think that’s not going to bring European-style central banking to the United States?
If you’re a corporation in Europe, the harder question is what to do with your free cash. The ECB wants you to buy stuff and drive up prices. That would leave you owning stuff, which isn’t rational if you think deflation will continue. So the ECB has a chicken-egg problem. They can’t have inflation unless businesses and individuals spend their cash, but everyone will hoard their cash until they’re convinced inflation is back.
Liquidity is another problem. Bloomberg calculates that the universe of corporate debt eligible for ECB purchase totals about €620 billion. To produce the desired effect, the ECB will have to own a significant chunk of that market. At some point it then stops being a “market” by any normal definition.
Japan is already dealing with that problem and worse, since it buys equity ETFs as well as bonds. The Japanese government bond (JGB) market is becoming a monopsony – the opposite of a monopoly. Instead of one seller, JGBs have only one buyer. It is very possible that other markets will soon operate similarly. How can the center hold in such an economy?...
Regardless, Draghi will keep buying assets. He could buy most of the Eurozone and still not have any inflation.
Speaking of cash-hoarding behavior – which is one side effect of negative rates – one of Germany’s largest banks is seriously considering it. Sources within Commerzbank havetold Reuters they are “examining the possibility” of hoarding physical euros by the billions in secure vaults. This would let them avoid the -0.4% NIRP penalty for parking cash with the ECB....
The only way that tactic makes sense is if the bank can’t profitably lend the cash to its customers, which, given the rules for lending in Europe, actually happens to be the case.
Nonbank financial institutions are also storing cash. Munich Re said back in March it would store both physical cash and gold to avoid paying negative interest rates...
...cease issuing 500-euro notes after 2018...
...How in the Wide Wide World of Sports does anybody think that pensions and insurance companies can survive in such a market? Remember, they are required to hold a certain amount of government bonds, and their investment return targets are north of 5%. I could do a whole letter on the coming debacle in European insurance companies. ...
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