On March 10, the European Central Bank announced an eagerly awaited new round of stimulus measures. This fell flat, and it has left some people wondering whether the bazookas of the central banks have become pop guns.
As Andrew Bosomworth put it, in PIMCO’s blog, the ECB ”ticked all the boxes”: targeted long-term refinancing operations (TLTROs); rate cuts; and stepped-up asset purchases.
The new series of TLTROs, collectively called the TLTRO II, will be launched this June, a series of instruments with a maturity of four years each, with borrowing conditions “as low as the interest rate on the deposit facility.” That is, the rates on the contemplated instruments can be zero or negative. Thus, the central bank might pay commercial banks to borrow its money.
The rate cuts include a cut on the aforesaid deposit facility, decreased by 10 basis points to -0.4%; a cut on the rate of the marginal lending facility by five basis points, to 0.25%; and a cut on the interest rate of the main refinancing operations of the Eurosystem, also five basis points, to 0.0%.
Asset purchases? The ECB announced that investment grade euro-denominated bonds issued by non-bank corporations will now be included within the assets eligible for regular purchases.
The Mechanistic Expectation
After these announcements, a naïf individual might have been excused for expecting two developments: that the value of the euro vis-à-vis, say, the US dollar, or China’s yuan, would fall mechanistically and drastically; and that stock values in the Eurozone would soar. That is the point, right? A central bank drives down interest rates so investors will have no reason to keep cash lying around – it doesn’t earn anything and actually costs them money while sitting idle. Since investors have to do something with their money, they shift chunks of it into equities. Meanwhile, the companies that are issuing those equities have easy access to cash themselves, and the weakened currency helps the region’s exporters sell their goods in the rest of the world. To the extent those exporters are exchange-traded companies that prospect should also increase stock valuations. Right?
There was a bit of a rally immediately after the announcement in both the DAX30 and the FTSE100. Neither rally lasted past 1 PM that day. In the afternoon trading, both indexes lost more than they had gained in the morning. DAX has started the day at 9723.09, ended it at 9498.15.
On subsequent days (Friday March 11th and Monday March 14) the DAX did resume a rise, closing the 14th at 9990.26. Was that because Mr. Market has slept on it, decided the stimulus required stock purchase after all, and got started on Friday? Perhaps that is so, although there are other possible explanations (for example, this week saw the price of Brent crude oil plateau out after a one-month rise.) Still, even if these two days of movement were a reaction to the ECB stimulus measures, it was of an unimpressive scale.
Let’s look at FTSE. Here too the initial boost from the ECB announcement was very short-lived, so it doesn’t show up except in intra-day charts. FTSE was down for March 10. It too, was headed up on the 11th and 14th but again not all that impressively.
What did the announcement do to the value of the euro? Again, there was some of the desired weakening, but not as much as the ECB must have expected. Further, in the following days the euro was slowing gaining strength against the dollar again, as traders awaited the Federal Reserve’s two day meeting the following week.
The Philosophy Lesson
The ECB seems to have tried to fire a bazooka, and to have created only a bit of a pop.
This is the sort of phenomena of which the Austrian economists have long warned. For the bank has to deal not with the world of mechanisms but with the world of humans, the world of trading, credit, investments, and analogous activities. This is a world where any equilibrium sets itself by virtue of minds capable of reflection and self-reflection. As humans, we respond not merely to incentives but to our knowledge that the other actors in the picture are also responding to incentives. This gives any system a vital, a non-mechanical, quality.
As a consequence of that, too, central bankers can’t just order up a certain desired quantity of stimulus. We may indeed be approaching a historic epoch in which central banking will become obsolete. And the central bankers will be the last to know.