Lagarde’s ‘Whatever It Takes’ Sequel Isn’t a Hit Yet


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Another day, another historic market intervention. The week after the euro dropped briefly below parity with the dollar, the European Central Bank unveiled its first hike in interest rates in more than a decade. Not only that, but it went beyond the 25 basis points hike it had trailed last month, and instead hiked by half a percentage point. That was a dramatic gesture that ended the era of negative interest rates in the eurozone — even if positive rates have still not arrived, as the ECB’s overnight rate is now 0%. And its president, Christine Lagarde, even formally abandoned forward guidance, for long one of the central bank’s key tools. From now on, decisions will be made “meeting to meeting” in reaction to incoming data. The ECB doesn’t know what the data will be yet, so it can’t guide the rest of us on what its monetary policy will be.

After months in which the Federal Reserve has busily raised interest rates in the US, this suddenly narrowed interest-rate differentials between the US and the European bloc. Steadily increasing fed funds rates helped to drive the rally of the dollar, and so the ECB’s dramatic intervention should have buoyed the euro. And yet it didn’t really happen:

Why? The interest rate rise, dramatic though it was, was presented merely as a matter of timing or front-loading. Lagarde said that the previously trailed 25-basis-points hikes were “plainly a package,” and that it made more sense to take a large step forward to exit negative rates. In combination with the withdrawal of forward guidance, this didn’t move the needle on longer term rate expectations much, if at all.

But the critical problem for the euro is that its viability is once again in doubt. Ten years ago, it was the ECB that effectively ended the sovereign debt crisis as then-chief Mario Draghi promised to do “whatever it takes” to rescue the euro. This time, the problem is more focused, but unfortunately it’s focused on Italy, the eurozone’s third-largest economy. And the market is still not convinced that the ECB can do what is needed to keep Italy in the eurozone. 

Desperation measures from previous crises are still around. The ECB can invest flexibly with the proceeds from the PEPP (Pandemic Emergency Payment Program), and Lagarde also reminded everyone that there are also OMTs. So-called Open Market Transactions were drawn up by Draghi to help fulfill his pledge and never used. They remain on the books, and Lagarde says they’re tools that can be used. 

But the main news was the arrival of the “Transmission Protection Instrument,” which will allow the bank to make sure its monetary policy works by buying bonds of countries whose yields are rising far out of line with others. Lagarde laid great emphasis that the board of governors had managed to achieve unanimity on the TPI. The press release outlining the instrument, which you can read here, goes so far as to say that purchases of private sector securities “could be considered, if appropriate.” She also underlined: “The ECB is capable of going big on that.” 

Under the TPI, the central bank can buy securities “to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy.” It gives a series of conditions, but no numbers. Any financial interventions will be wholly at the discretion of Lagarde and her colleagues. And to quote Jean Ergas, chief strategist of Tigress Financial Partners in New York, this means that “unwarranted” and “disorderly” could become the new “transitory.”

Decisions over intervention will hinge over definitional arguments about those words. And Lagarde’s promise that multiple indicators would be taken into account for deciding “warranted vs unwarranted” and “orderly versus disorderly” issues only added to confusion. Among the criteria she listed: The country must be in line with the eurozone’s accordance with fiscal framework, mustn’t have severe macroeconomic imbalances, nor an unsustainable public debt trajectory. And it must have sustainable macro policies. So in short, the ECB won’t help if a country deserves to have a higher spread. That’s a nasty echo of the morality-tinged arguments during the sovereign debt crisis a decade ago. 

Thus, the market didn’t like its first look at the TPI. In another echo of the past, we now need to return to watching the spreads of peripheral countries’ debt over German bunds. The extra spread in yield for Italian BTPs surged after the ECB’s meeting in June, when investors were disappointed not to get any details of a TPI-like instrument. An emergency meeting of the central bank helped to bring that under control. Now, the spread has risen back almost to its peak from last month: 

There is one critical difference with the first eurozone sovereign debt crisis. That one was truly existential and revolved around a group of countries on the area’s periphery known as the PIIGS (Portugal, Italy, Ireland, Greece and Spain), sometimes joined by Cyprus. This time, it’s about Italy. Portuguese and Spanish debt used to trade at a significant spread over Italian BTPs. Since the last Italian election in 2018 ushered in an ungainly populist and euroskeptic coalition, Italy’s debt has traded on a higher yield:

The pressure on the euro owes much to the awful coincidence that Draghi chose this of all times to depart as Italian prime minister. Markets were naturally more comfortable with a technocrat like him heading the government. More seriously, the current favorite to take the job next is Giorgia Meloni. She leads a party called the Brothers of Italy, which is directly descended from Benito Mussolini’s Fascist movement. 

There’s a fascinating debate over whether Meloni would really be as radical in office as she appears to be, or whether she might prove more pragmatic. Until the election in September, however, the chances are that markets will assume she’s the Italian Marine Le Pen. And whoever gets the job faces intractable economic problems, from low growth to an aging population.

Fixing Italy’s problems will be a task for decades. Meanwhile, the ECB stands ready with tools designed to repair previous crises. And if the Italian government brings a new one upon itself (in other words, a high spread becomes “warranted”), then it’s not clear that the central bank has a mandate to help, despite the risk to the eurozone. Hence, despite the historic and surprising end of negative rates, the euro is still barely worth any more than a dollar.

Cryptocurrency prices have stabilized of late after their eye-catching fall. That prompts important questions for investors that go far beyond the returns that can be made trading crypto. Has the contagion within the cryptoverse finally ground to a halt? That would be a big relief after the spectacular collapse of tokens on the Terra blockchain that set a string of firms to either declare bankruptcy or wipe out altogether. And what are the risks that cratering crypto prices could drive contagion in other markets?

Well, good news to the crypto faithful (and for everyone else), writes Isabelle Lee. Citigroup Global Markets believes the crypto contagion has reached its peak — at least for now. It also thinks that the risks of a crypto-driven systemic selloff are limited. It offers two reasons.

First, there’s the returning parity of the token stETH with Ether. For the uninitiated, Staked Ether, or stETH, represents staked or “deposited” Ether (the second-largest cryptocurrency by market value) on the Ethereum blockchain (the network where Ether runs). It is backed 1:1 by Ether and has become a popular collateral asset for lending and borrowing in decentralized finance. But for a while, the price disparity between stETH and Ether diverged widely, particularly when Celsius Network, a crypto lending platform that holds a large amount of stETH, halted withdrawals. Now that stETH is returning toward parity, Citi strategists see this as an “indicator of a reduction of financial stress in the crypto ecosystem.”

Second is the slowdown in stablecoin outflows. Stablecoins, tokens designed to maintain a peg to another asset like the US dollar, are frequently used as collateral for digital assets since their crypto reserves are “typically held in short-term commercial paper or US Treasuries,” the strategists explained. For now, outflows have stabilized, as seen below.

Perhaps more importantly,  even if the cryptoverse does blow up, it remains too small for contagion to spread in a “meaningful” way. Take Bitcoin, for example. Its market cap is comparable to that of a large US company (it would rank 10th in the S&P 500, between Nvidia Corp. and Procter & Gamble Co., while the whole crypto market stands at a little less than $1 trillion. Compare this to the US equity market at $34 trillion. If Bitcoin’s price ticked all the way down to zero, it would have roughly the same broader effect on total wealth as the bankruptcy of Nvidia or Procter & Gamble might do — certainly a major event, but not one that would bring down the financial system:

Further, while the value of Bitcoin has continued to increase, its takeup by conventional asset managers is still relatively limited. A plummet in the Bitcoin price would be very unlikely to prompt forced sales of stocks and bonds. To quote Citi:

“Crypto is probably isolated compared to broader financial markets. We believe most mainstream financial firms are waiting for further regulatory clarity or are still at an early stage of exploring crypto investing. We therefore don’t think, by itself, the crypto market travails will spillover into broader contagion.”

But while crypto might not act as a domino to knock down other markets, it’s also now clear that it’s not immune to contagion from the factors that have undercut conventional asset classes. Like stocks and bonds, crypto prices fell thanks to an aggressive Fed determined to tamp down red-hot inflation, along with recession fears, and continuing alarm about the ongoing war in Ukraine. 

“The crypto market is grappling with the same issues as financial markets… While correlations with equity markets have remained intact, we have not found obvious lead/lag relationships between crypto and equities around high frequency events such as the LUNA collapse. Contagion has remained relatively isolated within the crypto ecosystem, and was likely initially worsened by the challenging macroeconomic backdrop.”

For decades before the advent of cryptocurencies, the market adage was that “the only thing that goes up in a crisis is correlation” — and it turns out that Bitcoin and Ether are still subject to this. Their correlations to the stock market grew over the first months of the year:

Despite the more ambitious claims about crypto-evangelists, then, this is not a diversifying asset that comes to the rescue in tough times. Rather, it is increasingly pro-cyclical, making a bumpy road even bumpier. 

I’m still preoccupied by British politics. Who out of Rishi Sunak and Liz Truss will be prime  minister when the Conservative leadership election concludes in September, and how on earth did we end up with this particular choice? I ruminated on this with Therese Raphael, Marcus Ashworth and Adrian Wooldridge in a Bloomberg Opinion Twitter Space early Thursday, which you can find here.  I hope it’s of interest, although I’ll admit one problem is that we had very little difference of opinion about Truss — none of us thought she should be prime minister.

I’ve never met Truss, but viewed from afar it’s difficult to take her seriously. To explain why, watch this clip of Truss extolling British food exports when she was a trade minister, and contrast it with Jim Hacker’s defense of the British sausage from Brussels bureaucrats that won him the prime ministership in the great comedy “Yes Minister” from 1984. What was far-fetched satire almost 40 years ago now appears to be reality. And for a really interesting podcast take on all things politics, try The Rest Is Politics, featuring Alistair Campbell (once Tony Blair’s spin doctor) and Rory Stewart (a polymath who briefly looked as though he might have a chance to pip Boris Johnson for the Conservative leadership three years ago). 

I’m now going to go and jump in a lake for a week, to escape the heat. Stay cool everyone, and enjoy the weekend. More From Other Writers at Bloomberg Opinion:

• Bank of Japan Should Stop Meddling in Markets: Richard Cookson

• Customer Demand Is There. Supply Still Isn’t: Brooke Sutherland

• ECB Crisis Plan Fails to Convince Bond Traders: Marcus Ashworth

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of “The Fearful Rise of Markets.”

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