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A critique of the ECB's liquidity policies | 66 comments (66 topical, 0 editorial, 0 hidden)
Re: A critique of the ECB's liquidity policies (none / 1)
See Bloomberg's ECB Fails to Sterilize Bond Purchases With Deposits (February 1, 2011)
The European Central Bank failed to fully neutralize the liquidity created by its bond purchases for the third time since the program began.

The Frankfurt-based central bank said today it drained 68.2 billion euros ($93.9 billion) from money markets via seven-day term deposits, 8.3 billion euros less than the 76.5 billion euros it intended to absorb.

Also, it appears the conventional wisdom is entirely at variance with my analysis
The failure to drain the intended amount today adds further "downside pressure on overnight rates," said Christoph Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt.
Overnight rates may show a blip downwards on the day of the auction, but the 8-month trend in the interbank markets is up.

Note also this had been at the end of a run of bond purchases:

The ECB last week halted its bond purchases for the first time in three months.


Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 04:06:00 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 2)
The second failure was discounted for being at the end of the year: ECB Drains Less Cash Than Planned as Banks Stay Liquid Before End of Year - Bloomberg (28 December, 2010)
The European Central Bank failed to fully neutralize the extra liquidity created by its bond purchases for a second time since the program began in May.

The Frankfurt-based ECB said today it drained 60.78 billion euros ($80.66 billion) from money markets via seven-day term deposits, almost 13 billion euros less than the 73.5 billion euros it intended to absorb.

Banks tend to prefer to hold on to cash at the end of the year, when liquidity needs increase, said Karsten Junius, senior economist at Dekabank in Frankfurt. "The allotment therefore doesn't mean much for the situation in the money market," he said.



Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 04:22:30 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 1)
If you google for the first failure, you get not Bloomberg but Zero Hedge: Breaking: ECB Reports Failed Sterilization Auction, Demand For Fixed Term Deposits Comes At 0.6 BTC (06/29/2010)
A week ago, when noting the increasingly weaker results of the ECB's Term Deposit Operation, better known as liquidity sterilization, we said, to the usual ridicule: "With another auction next week, and then many more, all dependent on the amount of debt that Spain et al place "successfully", we expect the Bid To Cover to decline consistently, until we hit a 1 BTC and the ECB realizes its monetization program is a failure." It turns out we were right much sooner than expected: the ECB just reported a failed sterilization operation, attracting only €31.9 billion bids for the most recent, seventh sequential €55 billion auction, in which that amount of sovereign bond purchases had to be "laundered" through the system.


Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 04:40:27 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 1)
Zero Hedge's reaction to the second sterilization failure: Next European Leg Down? First Failed ECB Monetization Sterilization, As Central Bank Has E13 Billion Shortfall In Bond Bids (12/28/2010)
Today, to little fanfare, the ECB managed to obtain just E60.8 billion in tender interest for its most recent 7 Day SMP "peripheral bond monetization" operation, whereby it needed at least E73.5 billion to be able to offload all of its cumulative acquired sovereign bonds to other financial institutions: a de facto sterilization, which is why the ECB has so far been claiming it is not monetizing debt (as it constantly rolls the held balance on other bank balance sheets). That is no more: following today, the ECB is left with just under E13 billion in sovereign holdings and thus are not sterilized. ... And what is most disturbing is that this complete lack of interest (or telegraphed lack of bank liquidity) happened even as the marginal rate jumped by over 50%, from 0.6% to 1%- the same as the maximum rate allowed on an auction. ... Because despite what ING economist Martin Van Vliet told Reuters, "It has happened before but I wouldn't make too much of a big deal out of it", we would make a big deal out of it, as this has actually not happened before.
The entry is accompanied by a historical chart of all auctions up to that point.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 04:56:48 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 4)
What do you make of the overnight rate EONIA, that is supposed to rise as excess liquidity dwindles? It certainly spiked over the New Year, corresponding to a period where ECB sterilisation was failing, then fell and spiked again. It looks as if it's on an uptick at the moment after a considerable fall.

It's certainly become more volatile since mid-2010.

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Feb 24th, 2011 at 05:25:15 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 5)
That chart is scary.

You could say the interbank market used to work like a clock. Or, more appropriate, like a beating heart (which is actually quasiperiodic, unlike a clock). The last 8 months look like cardiac arrest.

The reference levels here are the ECB's deposit and marginal rates of 0.25% and 1.75%

The ECB pays 0.25% overnight for excess bank reserves, so this is a lower bound for EONIA as banks can always park their excess cash at the ECB instead of lending to each other. The baseline EONIA level seems to be 0.32%, or 7 basis points (hundredths of a percent) above the ECB's deposit rate.

The ECB charges 1.75% overnight for collateralised lending to make up for reserve shortfalls, so this is an upper bound for EONIA as banks can always borrow from the ECB at the marginal rate if the other banks charge them more for overnight lencing. The EONIA appears to have reached 1.30% in Early January, which is scarily close to 1.75%

But most importantly, EONIA used to have single-day spikes but now rates stay elevated for weeks on end.

This actually bears looking at a longer data series.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 06:46:21 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 2)
The EURIBOR site sends you to Thomson Reuters for historical series, and then only two months back.

But here's a site with the data. The regular heartbeat picture has not been standard over EONIA's history. See the crises of 2001 and 2008 (from another site because larger):

For 2009:

It could be read as injection of liquidity then careful tending of same from mid-2009... Followed in mid-2010 by sterilisation having, as you suggest, a net draining effect. (Though I suppose someone else might see a different pattern, turtles etc).

There's a similar stable heartbeat pattern in mid-decade, presumably between higher upper and lower bounds?

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Feb 24th, 2011 at 08:00:15 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 0)
I have a data series extending back to 2004Q4. I'll post tonight.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 08:53:09 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 1)
Now, would you describe this as "no signs of stress in the interbank market"?

Irish Banks Behind ECB Lending Surge - WSJ.com

The ECB's disclosure late last week that it had lent around €16 billion, or $21.90 billion--the highest levels since June 2009--under its emergency marginal lending facility left many financial-market participants searching for the cause.

...

The overnight facility used by the Irish banks carries a 1.75% interest rate. Irish banks are the euro bloc's heaviest users of the ECB's regular lending facilities, borrowing €126 billion in January, according to data from the Irish central bank. Some traders and analysts had speculated that the spike in ECB funding may have been caused by a liquidity crisis at a euro-zone bank.

Though the unexpected overnight-lending spike caught investors' attention last week, it didn't have much of an effect on bond yields or the euro because analysts didn't see evidence of broader stress in the banking system or short-term money markets.

It appears the analysts have a memory extending back only 24 hours. Over that time frame, yes, EONIA didn't show any signs of stress.

To be fair, my own view about the Irish MLF spike was that there was actually no cause for alarm since the banks responsible were already being restructured. But how you can claim that there are no signs of anything amiss in the interbank market escapes me. Last week's episode was simply due to Anglo Irish Bank and Irish Nationwide Building Society releasing some assets from being held as weekly collateral for the ECB's Main Refinancing Operations to being held as daily collateral for the MLF. This was done in preparation for a sale of €15bn-worth of deposits as part of the wind-down of the two banks.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 09:09:58 AM EST
[ Parent ]
"Abundant liquidity" (4.00 / 2)
Apparently no worries in this Tuesday 22 Feb report, with a contribution from an analyst we've see upthread:

MONEY MARKETS-LIQUIDITY PICTURE INCOMPLETE | Reuters

Banks opted to reduce their borrowing from the ECB at the central bank's seven-day tender, draining 17.5 billion euros. But markets awaited the results of tomorrow's three-month loan offering before changing their outlook on liquidity conditions.

The overnight interbank rate EONIA= -- which typically rises as excess liquidity dwindles -- was expected to continue its downward trend during the current maintenance period.

"Even if (ECB borrowing) would have fallen further I think the liquidity situation is abundant," said Commerzbank rate strategist Christoph Rieger. "Given that tomorrow we will have another 3-month LTRO with only 38 billion expiring ... I don't think overnight rates will increase on the back of these results.

Longer-term ECB loans worth 38 billion euros are due to expire this week, while banks have the opportunity to borrow as much as they need at a three-month tender on Wednesday.

Analysts said that with recent money market conditions proving volatile, the ability to lock in funding for longer duration at a stable rate had become more attractive and increased demand should see liquidity pumped back in to the system.

"tomorrow's three-month loan offering", which was yesterday, was fully taken up at €119.5bn.

"expected to continue its downward trend" - in fact EONIA went up again, from 0.497% on the 21st, to 0.531% on the 22nd, to 0.661% yesterday. Though that may only be an uptick.

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Feb 24th, 2011 at 10:10:49 AM EST
[ Parent ]
Re: "Abundant liquidity" (none / 1)
afew:
The overnight interbank rate EONIA= -- which typically rises as excess liquidity dwindles -- was expected to continue its downward trend during the current maintenance period.
Right, the maintenance periods are likely responsible for the heartbeat pattern. See ECB: Publication of the indicative calendars for the reserve maintenance periods in 2010 and 2011
The European Central Bank (ECB) is today publishing indicative calendars for the Eurosystem's reserve maintenance periods in 2010 and 2011. For the first time, these calendars are being published for the next two years, thereby following the practice adopted in setting the schedules for the meetings of the Governing Council of the ECB.


Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 11:31:18 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 0)
It looks that in 2007 overnight rates were pushed to a lower bound and have stayed there, punctuated by somewhat regular spikes upwards. This could be roughly consistent with the contraction of the shadow banking system's credit creation. Anyone who understood the implications of this metric would have suspected that trouble might have been looming, and conversely, those who suspected trouble could have produced the contraction.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Feb 24th, 2011 at 09:20:34 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 2)
The second graph is 2009, monthly. It certainly looks like deliberate intervention in midyear.
by afew (afew(a in a circle)eurotrib_dot_com) on Thu Feb 24th, 2011 at 09:34:11 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 1)
This is a version of the chart I made for the Eurointelligence column

You can see the ECB last changed its interest rates on 13 May, 2009. That's when the heartbeat pattern begins.

The ECB's refinancing operations had switched to unlimited liquidity on 15 October 2008 (a month after Lehman and the week after the global markets crashed on a Friday and the IMF warned of "a global meltdown").

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 09:45:53 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 0)
The second graph is 2009...

:-/  Thanks, I mistook the months for years. Makes more, if different, sense now. Certainly a dramatic change in pattern.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Feb 24th, 2011 at 10:39:19 AM EST
[ Parent ]
The EONIA heartbeat (4.00 / 2)


Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 03:49:50 PM EST
[ Parent ]
Re: The EONIA heartbeat (4.00 / 2)
Pretty clear. The deposit-MLF band was brought down swiftly in early 2009 to its current level which started in May, 2009. EONIA was stabilised (with moderate spikes on the cusp of one maintenance period to the next). Then, soon after the beginning of bond purchases, EONIA becomes much more volatile, trending upwards.

The sign there is something else at work since mid-2010 is that the deposit-MLF band has not changed. "Something else" could be sterilisation, or possibly aliens learning to use a Wii.

by afew (afew(a in a circle)eurotrib_dot_com) on Thu Feb 24th, 2011 at 04:25:58 PM EST
[ Parent ]
Aliens with Wiis (none / 0)
or frickin' sharks with frickin' laser beams attached to their frickin' heads.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 05:06:58 PM EST
[ Parent ]
Re: The EONIA heartbeat (none / 0)
One can see that it might make sense to raise interest rates.

For instance, raise the deposit rate by 0.50% to 0.75%, raise the refinacing rate by 0.25% to 1.25%, and leave the marginal rate unchanged at 1.75%.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 05:16:03 PM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 3)
There's a similar stable heartbeat pattern in mid-decade, presumably between higher upper and lower bounds?

As my data set doesn't extend back beyond 2004, I plot only from then.

The plateau in the middle of the chart with the ECB rates at 3-4-5% corresponds to the initial period of the crisis. The ECB raised rates by 0.25% on June 13, 2007, a week before Bear Stearns kicked off the financial crisis by closing its subprime hedge funds. Then the ECB was in a wait-and-see mode until March (around the time that Bear Stearns finally failed). You can see EONIA is rather chaotic during that period.

The other major qualitative feature of the chart is that prior to the Lehman failure interbank rates hovered above the main refinancing rate. However, since 15 october, 2008 (the start of the steep downward rate movement from the peak) the ECB MRO has been on "fixed rate, unlimited tender", which has allowed the banks to hoard cash and has dropped the interbank baseline to the deposit rate.

The fact that the baseline of interbank rates remains close to the deposit rate would seem to indicate that the banks are still hoarding cash. However, the ECB has been withdrawing liquidity from the system. The MRO is still "unlimited tender" but other "liquidity support" (in the form of unlimited auctions at maturities longer than a week) is being withdrawn. Here I have argued that the "bond sterilization" is, in fact, withdrawing liquidity too.

So, banks are hoarding cash but spare liquidity is very tight. This might explain the growing instability in EONIA. It might be a sign of very unequal states of health among European banks.

Looking into this I found the following from last September (with my emphasis):

But the two-pronged approach, while messy, could work. If unlimited cash was available only in one-week rather than three-month portions by then, the ECB would still get the normal impact from a rate hike.

"If you wanted to continue providing unlimited liquidity while raising interest rates, the system in Europe would in many ways facilitate that quite easily," said Societe Generale economist James Nixon.

"The impact of a 25 basis point hike would be exactly the same. It would just mean that overnight rates, instead of being centred around the ECB's main refinancing rate, would sit at a small margin to the deposit rate." The ECB's deposit rate is currently 0.25 percent, while the benchmark is 1 percent.

That could all change, though, if the health of vulnerable banks suddenly improved. Excess cash in the system would soon disappear as banks sucked it up, driving market rates the 75 basis points towards the refinancing rate.

Such a move, although likely to take time, would be bigger than any single interest rate hike in the ECB's history, and all without the ECB's finger going near the interest rate trigger.

(Reuters: Bank aid may be no barrier to ECB rate hikes, September 23, 2010)

By "suck up excess cash" Nixon doesn't mean "hoard" (which is what they're doing as the vulnerable banks are unhealthy) but actually "use".

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 02:24:10 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 0)
So the recent more prolonged spikes, taking EONIA above the refinancing rate a couple of times, could be the result of healthier banks looking for liquidity to use (ie lend and therefore inject into the economy), and having difficulty finding it because the ECB is tightening by sterilising bond purchases?
by afew (afew(a in a circle)eurotrib_dot_com) on Fri Feb 25th, 2011 at 04:40:37 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 3)
I'd say it's more about unhealthy banks scrambling for liquidity.

EONIA, unlike the ECB's MRO or MLF, doesn't require the posting of collateral.

So a bank all of whose clean assets are already pledged at the MRO needs to look at the unsecured interbank market. If they are paying more for Eonia than they would pay for 3-month Euribor it means the Euribor is closed to them.

A key difference between Eonia and Euribor is that Euribor is an offered rate whereas Eonia is the average rate at which actual overnight lending took place.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 04:54:01 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 2)
OK, got it. A little more reaches the light of day (mine, anyway) with each post.

Maieutics.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Feb 25th, 2011 at 05:01:46 AM EST
[ Parent ]
Maieutics (none / 1)
For me, too.

I understand a lot more now than a week ago, when I fired off the first inchoate version of my argument.

Appropriately, now I know more about how much I don't know. At least I have located a bunch of data I have yet to examine.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 05:24:37 AM EST
[ Parent ]
Known unknowns, huh? (none / 1)
(channelling Unca Donald)

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II
by eurogreen on Fri Feb 25th, 2011 at 10:08:37 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 1)
And a spike about once a month. Interesting. Audits or reports of some kind? Liquidity-stress from real economy (pay-day or something)?

Banking practise details needed here, I suspect.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Feb 25th, 2011 at 06:38:05 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 2)
Migeru:
the maintenance periods are likely responsible for the heartbeat pattern
I have not yet attempted to correlate the ECB's reserve maintenance calendar with the spikes.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 06:43:44 AM EST
[ Parent ]
More like tachycardia, (4.00 / 2)
which cannot be a good metaphor/analogy.

Reminds me very much of 'over-control' of a process by trying to constantly adjust inputs to reach a target output mean and variation, when the effect of the input differentials (plus unknown/unstudied system variables, of course) is not well known. I've seen it, for instance, in dimensional 'control' of glass crucibles via power-level manipulation in the fusion process.

paul spencer

by paul spencer (paulgspencer@gmail.com) on Thu Feb 24th, 2011 at 11:10:54 AM EST
[ Parent ]
Re: More like tachycardia, (none / 0)
Do we need a defibrilator?

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Feb 24th, 2011 at 11:20:50 AM EST
[ Parent ]
Re: More like tachycardia, (none / 1)
Perhaps a revolution.

paul spencer
by paul spencer (paulgspencer@gmail.com) on Thu Feb 24th, 2011 at 11:23:01 AM EST
[ Parent ]

A critique of the ECB's liquidity policies | 66 comments (66 topical, 0 editorial, 0 hidden)
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