September could be renamed “Sentralbankber”, as we eagerly await the Fed and BOJ on the 21st of the month, and of course the ECB this coming Thursday, all with extremely important decisions to make. With the ECB and BOJ expected by almost all observers to increase their stimuli, the Fed could be closer to a further rate hike. Yes, that threatened ¼% which has taken up so much space in all our lives may, “data dependent”, be upon us.
Whether the Fed does hike or not will trundle on, it does appear however that focus has shifted to the ECB predicament. It is widely expected that the ECB will increase QE (as the current program only has six months to run) with inflation not responding in any meaningful way and the expected Brexit shockwave not yet materialised. It would however appear that President Draghi and his colleagues have a small problem. There are real concerns as to what the ECB can buy if they do extend, they will need to slacken the rules they themselves imposed.
There appears to be four main rules which could be amended. The first is changing the issue and issuer limits, the maximum share of any single public-sector security central banks can hold stands at 33%, lucky they don’t have to play by the UCITS 5/10/40 rule. The second option is scrapping the rule that they have to buy debt yielding more than the deposit rate, currently -0.40% so bigger losses permitted? The third option is to expand purchases of new asset classes, equities and ETF’s could be considered, creating an even bigger bubble perhaps.
But the last option is the one we find surprising; changing the capital key. As readers will know we are benchmark agnostic as we feel fixed income benchmarks can be composed of the most indebted issuers and this is a flawed way to run portfolios. The ECB is considering altering the capital key which controls the amount of exposure per country based on the size of the economy. Currently with their EUR 1tn of exposure to government bonds EUR 238bn is in German bunds, EUR 189bn to French Oat’s and EUR 164bn to Italian bonds. By changing the capital key they would be able to buy more of the larger market, ie Italy, which has the third highest debt pile in the developed world.
This to us makes no sense at all as it would give Italian debt totally inappropriate pricing and indeed as Bundesbank President Jens Weidmann has said blurs the line between fiscal and monetary policy. Creating a false market for heavily indebted governments could cause big problems later as the payback period could extend the problems the country already faces. Also the ECB could be accused of financing government deficits, which is illegal under EU law, but as we all know rules are there to be broken, especially in the EU.