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By GEOFFREY SMITH
with ANJULI DAVIES, BEN MUNSTER and IZABELLA KAMINSKA
| SNEAK PEEK |
— Eurozone consumers give ECB the benefit of the doubt.
— The ECB’s Target2 securities annual report points to possible March settlement mayhem.
— The truth is out there, but is it being priced into global liquidity?
| POLICY TICKER |
ECB 3.75% ⇡ — BOE 4.5% ⇡ — FED 5.35% ⇡— SNB 1.5% ⇡— BOJ -0.10% ⇣— RBA 4.10% ⇡— PBOC 3.65%⇣— CBR 7.5% ⇣ — SARB 8.25% ⇡
Good morning and welcome to Wednesday. What we want to know this morning: Is the European Central Bank going to get away with a “surprise inflation” episode? The textbooks and gut instinct tell us ‘no’, but the data is starting to look as though it might.
Send tips to [email protected], [email protected], [email protected], [email protected]. Tweet us, too: @Geoffreytsmith, @JohannaTreeck, @Ben_Munster, @izakaminska
| DRIVING THE DAY |
— German April industrial production, 8 a.m.
— Chinese May trade data, 5 a.m.
— Bank of Canada rate decisions, 4 p.m.
CHINA SNIFFLES: Chinese trade data for May will be out by the time this newsletter hits your inbox and, in contrast to the RBA decision yesterday, I shall not be getting up early for it. The numbers are likely to attract even more attention than the German output numbers for April (due at a more civilized hour), given that markets have clearly still not finished repricing the outlook for Chinese growth this year. German orders data yesterday offered only the deadest of dead cat bounces to start the second quarter.
CANADA’S GROWTH PROBLEM The dark days of January feel like a long time ago now. That’s when the Bank of Canada became the first major central bank to pause its rate-hike cycle. But ahead of today’s Governing Council meeting all bets are off as to whether it can stay on that road. Canada is faced with a bit of a conundrum. Growth has been on a tear — GDP rose 3.1 percent on the year in the first quarter — and the labor market and wages have remained robust. The economy, meanwhile, added 41,000 jobs in April, more than double consensus estimates. Inflation, having begun to fall back, rose for the first time in 10 months in April to 4.4 percent, with house prices picking up steam again.
A hawkish hold? Like its peers, the BoC has just been through its fastest tightening cycle in its history, raising rates eight times to a 15-year high of 4.5 percent in the past year as inflation peaked at 8.1 percent. Markets are now pricing in a 45 percent chance of a hike today. The possibility was discussed at the last meeting in April, according to the minutes, and Governor Tiff Macklem has been known to surprise the market in the past. Others will be looking just for a shift in tone. “The run of sturdy data undoubtedly raises the odds that the Bank of Canada needs to go back to the well of rate hikes,” BMO’s Douglas Porter reckons, even if today’s meeting may just come a little too soon for that.
Loonie tunes. The Canadian dollar, the loonie has been the best performing G10 currency in the past month on the back of strong economic growth and what’s going on in its southern neighbor, where expectations of a Fed rate pause have grown. Look out for the decision at 4 p.m. CET.
| ECONOMIC INDICATORS |
WHAT WAGE-PRICE SPIRAL? An ECB survey on Tuesday showed a sharp drop in consumers’ expectations for inflation a year hence, perhaps the clearest sign of public confidence yet in its ability to head off a wage-price spiral despite losing control of inflation for nearly two years.
The benchmark German 10-year bond yield, which we’ll take as our rough proxy for long-term inflation expectations, is corroborating that survey. Having risen by nearly 3 percent since the middle of 2021, it hasn’t posted a new high in three months. If you think of the 10-year yield as a rough average of where people expect short-term rates to be over that period, then you would struggle to argue that the ECB has permanently “lost credibility” as a result of the last two years.
At first glance, this seems strange, to say the least. The euros that an investor used to buy a 10-year bond in 2020 have already lost around 18 percent of their purchasing power, and will lose more over the next seven years. And yet, the same investors are still willing to finance the German government for a little over 2.3 percent a year over the next decade. This is not what the market’s punishment of currency debasement is supposed to look like.
This, the ECB would argue, is the very essence of credibility. Its critics would call it the very essence of gaslighting.
Strategic debt debasement: In the meantime, wages and tax payments have also swollen in nominal terms due to inflation, making the huge legacy debts of eurozone governments easier to bear. Despite borrowing trillions to pay for furlough schemes, to cover tax shortfalls and then to subsidize energy consumption after Russia’s invasion of Ukraine, eurozone debt will still only have risen by 6 percent of GDP by the end of this year, relative to its 2019 baseline, according to the EU Commission’s forecasts
Seeing risk premiums so compressed despite its failure to manage risk since 2020, it will be tempting for the ECB to think that it has “got away with one”. However, any satisfaction in Frankfurt will be tempered by the awareness that finance ministers, too, will think they have got away with a surprise inflation. And once they get the idea that they can get away with the trick, then the central bank really will have its work cut out.
| SETTLEMENT |
MARCH MIGRATION MAYHEM? Those who made it to the end of the ECB’s Target2 Securities annual report, out on Tuesday, well done. Not the most gripping read, but it certainly conveyed the big settlement story of the year which was the eurozone’s preparation for a system-wide migration to a real-time gross settlement (RTGS) system operated under a “central liquidity management” framework. The date flagged for the migration? Why, none other than March 20, 2023 — the morning after the weekend of UBS’s unceremonious shotgun marriage with Credit Suisse.
Did the migration exacerbate financial panic? Could be. Days before the great migration — March 17 to be specific — a gathering of the ECB’s Money Market Contact Group (made up of representatives of all the major eurozone banks) fretted about this very possibility. As the meeting’s summary now reveals: “Several members mentioned the unfortunate timing of the T2/T2S migration over the March 18/19 weekend, which could have contributed to distress in the market in case of technical issues.”
But there’s more! Members also worried technical issues could be misinterpreted by markets as being liquidity-related. “A clear communication by the ECB would have been extremely important in order to clarify the technical underlying cause of any disruptions, so that markets did not misinterpret them as a liquidity issue and react in panic,” the summary noted.
It wouldn’t be the first time. A big rejig in how Greek bonds settled on the HDAT system in late 2009 coincided with the beginning of trouble for the broader Greek bond market and the emergence of the eurozone sovereign crisis. When the system was rejigged again in April 2010, the bonds sold off even further.
| COMPLIANCE |
LIBOR FALLOUT CONTINUES: Former Labour shadow chancellor John McDonnell hosted the BBC’s Andy Verity in House of Commons committee room 11 on Tuesday evening to discuss his new book Rigged, a revealing account of what really happened with Libor rigging. The book draws on leaked recordings (never shown to trial juries at the time) to argue that the wrong people were sent to jail because the instructions to manipulate Libor came first from top bosses, and even central banks and governments.
Tearful recollections: The emotionally charged session heard from four of those either convicted or acquitted as a result of the Libor prosecutions: Peter Johnson, Tom Hayes, Carlo Palombo and Daniel Wilkinson. Speaking for the first time publicly about his experiences, Johnson, who the tapes depict as objecting to senior Barclays management requests to ‘low-ball’ rates, said: “I’d always prided myself on my moral compass and I thought that I was one of the good guys, but somehow I ended up in prison.”
POINT OF ORDER: McDonnell and Tory MP David Davis last month raised the affair in parliamentary sessions, urging the Treasury Select Committee to initiate a fresh inquiry on grounds that MPs may have initially been misled. Former UBS trader Tom Hayes, who served five and a half years in prison after being found guilty of conspiracy to defraud in 2015, told the gathering that “maybe Libor was broken and needed revision but to prosecute those who operated within the system retrospectively lacks legal certainty and is, in the words of the US second circuit, ‘not in the interests of justice’.”
| FINTECH |
SEC GOES ON CRYPTO ATTACK: Having slammed crypto platform Binance with 13 independent charges on Monday (neatly condensed by Stephen Diehl in this Twitter thread), the U.S. Securities and Exchange Commission set its sights on the OG crypto platform, Coinbase, on Tuesday. Coinbase now stands accused of operating as an unregistered securities exchange, broker and clearing agency. Shares fell over 12 percent on the news.
But didn’t they just IPO? You betcha. And that’s what makes the move all the more controversial. The public listing back in April 2021 de facto endorsed the stock to mom and pop investors. But as Izzy pointed out in the Financial Times at the time there was always a risk regulators could force Coinbase to be regulated as a broker-dealer or an exchange rather than just a money transmitter under the U.S. Money Services Business legislative framework.
It pays to read the small print: Fans of the crypto service have blamed the SEC for not providing enough regulatory clarity ahead of the IPO. But the SEC countered that “declaring effective a Form S-1 registration statement does not constitute an SEC or Staff opinion on, or endorsement of, the legality of an issuer’s underlying business”. Others have pointed to the risk factors in Coinbase’s own prospectus, which clearly set out that “persons that effect transactions in crypto assets that are securities in the United States may be subject to registration with the SEC as a ‘broker’ or ‘dealer”. We imagine the charges pave the way for AT1-style investor grievances, but in crypto.
| PAPERS, PLEASE |
SO RELATABLE! The ECB’s Sarah Mochhoury put out a somewhat self-congratulatory working paper observing how relatable ECB comms have been with the general public, especially in and around the pandemic. “I find that the ECB’s simplified and relatable communication contributes to higher levels of trust in the ECB,” she noted, while unearthing the not at all self-evident finding that “participants are more likely to report an improvement in their perceptions of the ECB… when they are confronted with” — wait for it — “simplified communication relative to the technical communication.”
Leveraging Cbankfluencers: Mochhoury further concluded that trust in the ECB is closely connected to familiarity with the ECB President, recommending to “further leverage Madame Lagarde’s social media channels and speaking engagements to share relatable content relevant to the ECB’s policy action in order to build understanding of, and trust in, the ECB among the general public.”
One can’t help feeling that, with bunds still trading at a negative real yield of 4 percent, Ms Mochhoury is, if anything, under-selling her employer’s communication skills.
| SPEAKER’S CORNER |
SOFT-PEDALING: Dutch central bank governor Klaas Knot is one of the most hawkish on the block, but even he was soft-pedaling the need for more hikes in a speech to the European Stability Mechanism on Tuesday.
The Financial Stability Board head sounded dangerously close to being, dare we say it, relaxed about the current situation, with interest rates being high enough to start choking inflation without — yet — triggering any accidents.
But the caveats weren’t far behind: some “corporate liquidity issues” may well be around the corner as refinancing needs drive the debt servicing burden higher, he warned, adding that the same principle is at work for euro area sovereigns and noting that the low rates of the last decade “can only buy time rather than obviate the inevitable adjustment in the primary fiscal balance.”
| FINANCIAL STABILITY |
NANU NANU: The internet has been ablaze ever since The Debrief in conjunction with investigative journalist Ross Coulthart at News Nation revealed that David Grusch, a former intelligence officer at the National Geospatial Agency (NGA) and the hyper secretive National Reconnaissance Office (NRO), had come forward with extensive classified information about the non-human origin of aircraft retrieved intact and partially intact by the United States government. The 36-year old American has alleged this sensational information has been illegally withheld from Congress.
It’s financial risk, Christine, but not as we know it: What inquiring market minds want to figure out is how much financial risk is embedded in the discovery of “unique atomic arrangements and radiological signatures”? We reached out to former cbanker and international financial markets expert Robert McCauley for a quick take. Speaking hypothetically, he noted “any rapid advance in metals science could lower the value of the current fleet of commercial aircraft, causing losses to creditors and outright owners.”
On a well-organized planet, however, the discoveries could only be helpful in the long run, McCauley added — assuming they were free of pathogens. Short-term, however, “they could ‘strand’ capital assets, including human capital.”
Unfair advantage: Helen Mccaw, a former Bank of England economist who worked on financial stability until 2011, but has since been engaged in monitoring UAP risk, told Morning Central Banker so-called disclosure could inject mass uncertainty into financial markets. “There may be price volatility due to suspicion or accusation that specific companies have been given illegal uncompetitive advantages from governments engaged in the retrieval and reverse engineering of recovered advanced non-human technology,” she said. She also cautioned it might become difficult to price assets using familiar methods.
Time for pragmatism: Pippa Malmgren, economist and former adviser to George W. Bush, meanwhile, noted on her Substack it may not be all bad: money will no doubt soon be made in backing the exploration of anomalous phenomena.
For more, see POLITICO Magazine’s piece on why the benefits of disclosure to humanity may outweigh the fear of discovering we’re not alone in the universe.
| WHAT WE’RE READING |
— China’s state banks told to lower cap on dollar deposit rates (Reuters).
— Sequoia splits into three firms amid geopolitical tension (Bloomberg)
— World Bank raises world GDP outlook for 2023, cuts for 2024 (World Bank)
THANKS TO: Ben Munster, Anjuli Davies and Izabella Kaminska.
| WHAT’S ON |
WEDNESDAY, June 7
— RBA Governor Lowe speaks, 1:20 a.m.
— China May trade data, 5 a.m.
— German April industrial production, 8 a.m.
— U.K. May Halifax house price index, 8 a.m.
— Bank of Canada rate decisions, 4 p.m.
— ECB VP de Guindos speaks at a Commission/ECB event on financial integration in Brussels, 9:50 a.m.
— ECB’s Panetta moderates a discussion panel on “Completing the Banking Union” at the same event; ECB’s Fernandez-Bollo also participates 11:10 a.m.
All times CET, unless otherwise noted.
