Webcast 033 | Losing interest: why negative interest rates present a challenge to global growth

It has been a tough start to 2015: what will be the outcome of persistently low interest rates be? Rebecca Harding and Sarasin & Partners’ Subitha Subramaniam discuss the topic.


Webcast 033 Author  |  Rebecca Harding  |  CEO

Asset Management | Asset of the month: EUR/USD

Delta Economics’ asset price forecasting model is giving strong indications that the euro will weaken in April, in line with the model’s predictions that there will be EUR/USD parity by the end of 2015. We forecast a highly volatile month for the euro, with high resistance given that parity is a psychological barrier, particularly in light of the upcoming UK elections and continuing anxiety around a Grexit.

We suggest short positions for the current month and expect that the euro could go as low as 1.01 against the dollar in April. Our analyses show it could reach 1.0035 at an extreme.

The weakness of the euro is a direct product of the confusion created by the European Central Bank’s implementation of Quantitative Easing in March, seen as both too little, too late, and given broader uncertainty around the effectiveness of the strategy. Further, a weak euro is linked to a strong USD, in turn a product of the anticipation of a rise in interest rates, as well as weaknesses evident in Asian markets. The dollar will strengthen further nearing parity, which Delta Economics’ expects to see after April.

Medium term nervousness around sustained Greek membership of the eurozone and contagion effects of any debt renegotiation is putting further downwards pressure on the euro: this pressure is likely to intensify in the coming few weeks. We expect major movements in the market at the start of April, with high volatility throughout the month.



Webcast 031 | QE, Central Banks and Europe’s Future

As the ECB’s Quantitative Easing programme gets underway in an attempt to reflate the eurozone, questions remain over how effective it will be. Rebecca Harding and Shaun Richards discuss.


Webcast 031 Author  |  Rebecca Harding  |  CEO

Webcast 030 | Lessons from QE in four charts

March 2015 marks the start of Quantitative Easing (QE) in Europe. Given broader uncertainty around the effectiveness of QE, what lessons can the ECB learn from QE in the US, Japan, and the UK?



Webcast 030 Author  |  Rebecca Harding  |  CEO

Lessons from QE in four charts

Why nothing should be taken for granted  |  March 2015 marks the start of Quantitative Easing (QE) in Europe. The much anticipated programme will inject €1.1tn into the eurozone’s coffers up to September 2016 at a rate of €60bn per month from next month. The European Central Bank will be purchasing national government bonds from member states and, in so doing, it will have become the “lender of last resort” in Europe at last ceding to demands that it provides a backstop to Europe’s fragile sovereign nations in the wake of the financial crisis.

While this has created an uneasy truce between markets and Europe, there is still a long way to go. With QE, systemic risk from sovereign default is avoided and the immediate impact has been to boost equity markets and weaken the value of the euro. Theoretically, this should boost confidence and exports. However, the volatility in markets at present is a product of the broader uncertainty around the effectiveness of QE. Markets need to be convinced that it was the right strategy in the first place, not least because of the broader uncertainties around European geopolitics at present, and are in a mood to test European policy makers in any way they can.

One of the principles of QE is that it reduces the value of the currency and thereby supports real economic growth through exports. Here are the lessons from that trade perspective in four charts:


Chart 1  |  US QE – market correction overdue




Figure 1  |  Monthly Value of US exports (USDbn) versus S&P 500, last price monthly
Source  |  DeltaMetrics 2015, Bloomberg


The chart shows the close correlation between monthly movements in trade and the S&P 500 at 0.715. Each horizontal line shows the start of a QE programme: December 2008, November 2010 and latterly September 2012. US exports during that time have grown modestly, while the S&P 500 has increased in value substantially faster than its pre-crisis rates, particularly since QE3 in 2012. It appears that one effect of QE has been to worsen the disconnect between asset values and the real economy up to the start of this year.


Chart 2  |  Abenomics and the paradox of the yen




Figure 2  |  Monthly value of Japanese exports versus JPY per USD spot price, Last Price Monthly, June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


Japan’s relationship with QE has been a long one and has produced a bizarre result: except for the period between October 2004 and May 2007, the relationship between the strength of the yen and exports has been the reverse of what would be expected. As the value of the yen strengthened between June 2001 and October 2004, exports increased. Similarly, as the value of the yen decreased shortly before the implementation of Abenomics in 2012 through to Shinzo Abe’s final asset purchases in October 2014, export trade actually fell. This is a lesson for the developed world economies: exports are currency inelastic and therefore depreciation is unlikely to have much impact on export-led growth.


Chart 3  |  UK QE and the export mystery


The purpose of UK QE was arguably to protect against systemic risk and loosen up the supply of credit in the banking system to enable bank-to-bank lending. It did not have as its primary focus either exports or real growth. However, as the rest of the world started to pull out of the downturn in the wake of the financial crisis, the question of why sterling had depreciated so much without any impact on exports took on renewed importance. The Conservatives, elected in 2010, set export-led growth as its target and set a goal to double UK exports between 2010 and 2020 to a value of £1 trillion.




Figure 3  |  Monthly value of UK exports (USDbn) vs EURGBP spot (value of 1 euro in sterling), June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


UK QE started in September 2009 and was boosted further in October and November 2009. In October 2011 an additional £75bn in QE was announced followed by £50bn each in February and July 2012. Rather than causing the value of sterling to drop, the immediate market reaction was for it to strengthen. Interestingly, the terms of trade are negatively correlated with the value of sterling at -0.754. In other words, exports will grow in value in relation to imports as the value of the currency depreciates. This is exactly as it should be. Yet the facts demonstrate a very weak correlation (0.466) between the value of sterling and exports. QE has strengthened rather than weakened sterling, as in the US, especially against the euro but even so, sterling has not returned to its levels against the euro of 2001 and has therefore depreciated over the whole period, as have exports.


Chart 4  |  QE in Europe – a combination of both?


Previous trade views have expressed scepticism at the impact on trade of any reduction in the value of the euro. Like Japan, the eurozone’s trade is highly currency inelastic and, as a result, the depreciation of the euro is unlikely substantially to increase exports and therefore provide a much-needed boost to growth.




Figure 4  |  Monthly value of eurozone exports (USDbn) vs Dax Index, Last Price Monthly, June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


However, it is likely that the value of European stock markets could increase substantially. The Dax has reached all-time highs since QE was announced and this creates as substantial a disconnect between economic fundamentals and equities in Europe as there has been in the US and the UK. But this QE-induced asset boost, unlike in the US, comes without an accompanying boost to the real economy in the form of infrastructure spending. Instead, it may well come with restrictions on real growth if sovereign responsibility is tied to austerity rather than structural reform and long-term growth.

Policy makers in Europe now have to ask which lessons they want to learn, and from which chart.

The Fallacy of Quantitative Easing

There is no doubt the EU project has benefited the German economy above all else: a bit like the cat got all the cream and then some. But it cannot be put off any longer; as Voltaire once said, with great power comes great responsibility. In an unusual act of defiance against German apprehension to the ECB’s sovereign bond-buying programme, the ECB will press ahead with QE1. There will be a week to thrash out the exact details after the ECJ verdict on 14th January on the legality of such a move, but a formal announcement is expected on 22nd January.

The decision to “press the button” is more likely now than ever before given the falling prices in the Eurozone. Some would argue that we are being too quick to diagnose a deflationary spiral: that these are just temporary falls in prices. The truth is that falling prices were evident in the Eurozone long before the recent external (oil) supply shock took effect. Europe’s problems run much deeper.

In the short term, any announcement in QE is unlikely to be large enough or make a significant impact on economic fundamentals: much like plugging holes in a leaking dam. QE will only act as a plaster over the real structural differences that besiege the Eurozone. Indeed, some of the world’s major economies have implemented QE with dubious results: the USA has been through three rounds of QE with more favourable outcomes, however, whether that’s purely down to QE or other more dynamic variables has yet to be proven. The UK has gone through two rounds: with the first being more effective than the second. Japan on the other hand has had to endure NINE rounds of injections (yes, QE9!) with little effect. Even after 20+ years, the legacy of deflation is engrained and growth remains elusive.

In the more medium term, what is clear is that QE will contribute to bloating banks’ balance sheets, with little in the way of affecting the real economy. This is unlikely to prompt banks to lend more. On the contrary, the winners of QE will be the bond holders, mostly the well-off, whom are unlikely to spread to the gains evenly around the economy, but would rather pile into assets thus further perpetuating asset price inflation. It’s an inefficient allocation of resources: the “wrong” people are being targeted.

What else if not QE one might ask? Recent reports suggest that Japan is toying with the idea of implementing a more innovative monetary policy tool known as “helicopter money”: dropping money directly into the pockets of every citizen. Whilst this would target the “right” people, it may all be too radical for the bureaucrats of Europe. Many economists view this measure with great suspicion partly because it hasn’t been tested robustly enough. However, the belief that prices will fall further may already be entrenched into the minds of EU citizen, so any windfall in the way of helicopter money (if too small) may be squirrelled away rather than spent on stimulating the local economy. Introducing a voucher- based system for certain goods and services is marginally better, but this too comes with a host of complications in terms of which good and services qualify, and ensuring money is not leaked out of the system.
It will need more than QE to resuscitate the Eurozone. A Eurozone break up is out of the question no matter how necessary it may be in economic terms: politics will trump economics. What is more likely is that there will be QE-light – but this still falls short of what is really needed: further structural reforms and deeper fiscal consolidation. One thing is for sure: being timid never got anyone anywhere…


The Fallacy of Quantitative Easing  |  Author  |  Shefali Enaker  |  Economist