POLITICO Pro Morning Central Banker: Groupthink — CPIs — Lira losses

Our one-stop source for central banking & monetary policy news.

By GEOFFREY SMITH

— Cbank groupthink needs busting, former Pimco boss Mohamed El-Erian tells our Twitter Spaces.

— Goldman points to “deposit beta” miscalculation as source of recent banking troubles.

— Turkish Lira losses are accelerating as the CBRT runs out of ammo.

ECB 3.25% ⇡ — BOE 4.5% ⇡ — FED 5.25% ⇡— SNB 1.5% ⇡— BOJ -0.10% ⇣— RBA 3.85% ⇡— PBOC 3.65% ⇣— CBR 7.5% ⇣ — SARB 8.25% ⇡

Greetings and welcome to Wednesday, and well done for making it through the first day back after a long weekend — especially if, like me, you always find yourself wondering at the end of May how you ever managed a five-day week in the first place. Tuesday’s missives out of Frankfurt made clear that we should all expect some long weeks ahead over the coming months, as the squeeze of higher interest rates exposes the vulnerabilities of a system that has spent too long under the comfort blanket of excess liquidity.

— Germany (2 p.m.), France (08:45 a.m.) and Italy (11 a.m.) release inflation data for May

— ECB releases its latest Financial Stability Review, 10 a.m.

— US April Job Openings and Labor Turnover Survey, 4 p.m.

Inflation data are front and center this morning, with preliminary May numbers due from Germany, France and Italy. The headline numbers could be a bit wild, as big drops in wholesale energy prices over the winter finally feed through into household bills. Nomura’s Andrzej Szczepaniak points out that there will be a particularly big impact in Italy. The ECB will be hoping for some releases that look like Spain’s yesterday, where core inflation also slowed as well as the energy-driven headline number. 

And when you’ve digested those releases, put your feet up and watch the reaction to ADP’s private payrolls survey and the JOLTS for April, the first of the week’s warm-up acts for the labor market report on Friday.

The ECB will also publish its semi-annual Financial Stability Review at 10 a.m. CET. The cat is already out of the bag after yesterday’s release of two excerpts that carried more red flags than the average IG Metall protest (see summary below). This line, for example, is positively pregnant with overtones of doom: “both market liquidity and funding liquidity conditions might be more fragile and flightier than the aggregate measures for liquidity suggest, and they therefore warrant continuous monitoring.” In other words, the ECB doesn’t trust its own (or anyone else’s) statistics.

CBANK GROUPTHINK NEEDS BUSTING: Former Pimco boss Mohamed El-Erian, now chief economic adviser for Allianz, didn’t mince words about who or what he felt was to blame for the West’s precarious financial predicament during a central-bank themed Twitter Spaces hosted by Izzy on Tuesday. It was the Fed — and the related institutional groupthink it inspired.

“The central banks are dealing with a very difficult policy challenge, mostly of their own making,” he told a lively session, urging services like ours to hold central banks accountable “because one of the other failures is that even when they started realizing they were wrong, they did not course-correct.”

Let me count the ways: El-Erian listed six main ways he believed the Fed failed the system: a lack of solid analysis, a lack of action when needed, poor forecasting, a lack of sound supervision and regulation, and most grating of all, inconsistent communication. “Right now you have Fed officials all over the map for a meeting coming up in a week,” I don’t he said. “Some think the Fed should hike, some think pause, some think skip and you have some that regret hiking in May … that in itself is causing volatility.”

Separation anxiety: The big question from now on will be to what extent the separation principle — that’s the idea that tackling inflation doesn’t have to come at the cost of financial stability for central banks — can be efficiently enforced. “The classic dilemma is how do you lower inflation without sacrificing economic growth… Now we have a trilemma,” El-Erian said. “How do you reduce inflation without bashing growth and at the same time causing financial instability? The policy challenge is much bigger right now.” For those who missed it, the ECB’s Isabel Schnabel recently concluded similar, although it took her no less than 30 successive Tweets to get there (it worked fine as a speech, honest).

The one that got away? The ECB may have largely escaped blame for now, but according to Hedge Analytics’ principal Meyrick Chapman, that’s only because of its lack of transparency relative to other central banks. “If you want to understand exactly what’s going on the balance sheet of the ECB it is very hard. You have no transparency on the asset purchases,” he told the Spaces session. “The fact that the ECB hasn’t been mentioned very much, isn’t because they’re doing everything, right, it’s because we don’t know what it looks like.”

The discussion also featured the wise words of James Aitken of Aitken Advisors, who noted the Fed’s bank-term funding program was possibly the most generous funding in place short of QE… while Nicolas Véron of the Peterson Institute said there was no doubt that the Fed, at least as a banking supervisor, now had egg on its face. You can listen to the full session here.

QT’S LIQUIDITY MISMATCH RISK: The business of banks is to borrow short and lend long, while simultaneously managing interest-rate exposure. But higher interest rates and other measures by central bankers to drain huge excess reserves have left the system vulnerable to mark-to-market losses on trillions of dollars worth of supposedly safe assets. Now that the BIS is formally calling for a return to a scarce reserves regime [here’s looking at you, Claudio Borio] policymakers are wondering how far the problem may extend beyond a few bad apples like Silicon Valley Bank. 

The bad news is that even in Europe, many institutions could struggle, according to a teaser from the ECB’s Financial Stability Review on Tuesday. “Banks might not be able to adjust the maturity of their liabilities overnight once QT is underway and might face exposure to liquidity claims by non-banks and non-financial corporations,” the review snippet read. The ECB will reveal more about its thinking on the topic when the full review is published today.

So why can’t banks do basic banking anymore? Goldman’s economic research team has an idea. In a note out over the weekend, chief economist Jan Hatzius and team argued that new academic research implies the problem might transcend rate hikes or even the inverted yield. It lies instead with an error in how banks currently calculate deposit stickiness. 

‘Deposit beta’ in the spotlight: The concept is simple. Banks don’t use interest rate swaps or other sophisticated derivatives to hedge interest rate risk. They match their interest income with that of their expenses, i.e. their deposit franchises. This calculation is known as “deposit beta”.  But, say the analysts, an abrupt shift from a slow-and-low Fed hiking cycle to an unusually rapid one invited miscalculation, as has the impact of technological changes like online banking and social media that have made it easier to withdraw funds. “Mistakes in managing interest rate risk caused by misestimating these parameters can be quite costly, especially when interest rates change quickly,” they noted.

PROFIT-LED INFLA–, WAIT, WHAT? The campaign to blame corporate profiteering for the surge in U.K. inflation bumped into an inconvenient truth on Tuesday. The Office for National Statistics’ showed that non-financial companies’ net rate of return stayed stuck at 9.8 percent in the fourth quarter of last year, leaving it basically unchanged from the start of the pandemic, both for services and manufacturing. 

Advocates of the ‘greedflation’ narrative, such as Socgen’s Albert Edwards, can still point to more recent data that has shown producer output prices holding up better than input prices. This suggests that manufacturers are indeed trying to bolster profit margins. But, hey, #GLWT as the great mortgage reset grinds on. For what it’s worth, the British Retail Consortium’s shop price index on Tuesday also played down any notion of margin expansion, but then — to quote that distinguished macroeconomist Mandy Rice-Davies — it would, wouldn’t it?

NO PRICE STABILITY IN SIGHT:  Financial market experts don’t expect inflation to fall back to the ECB’s two percent target in the coming years, a survey conducted by Germany’s ZEW showed.

Analysts polled in May expect median inflation rates of 5.8, 3.5 and 2.5 percent for the years 2023, 2024 and 2025 respectively. Expectations were trimmed slightly for this year from 6 percent in February but remained unchanged for 2024/5.

Wage worries: While falling energy prices and tighter monetary policy drove some downward revision in inflation estimates, rising wages are pulling in the opposite direction. Some 70 percent of those polled have raised their inflation forecasts since February due to wage developments, ZEW said, some of them “significantly”.

FEELING WORSE, BORROWING LESS: Signs of a eurozone slowdown are multiplying thick and fast. The ECB’s money and credit data for April showed private-sector credit growth slowing to 1.9 percent on the year. The adjusted flow of loans to households was the weakest in nearly three years, while loans to companies fell for the fifth month out of the last six. 

Gloomy sentiment: The reasons aren’t hard to find. In addition to banks tightening their lending standards, both businesses and consumers are getting more pessimistic. The EU Commission’s monthly sentiment survey showed both the consumer and industrial indices falling in May, and to make it worse, neither consumer expectations of inflation, nor businesses’ expectations for selling prices, fell as much as expected. 

ABOUT THAT T-BILL DELUGE: U.S. financial markets never fail to surprise. With the debt ceiling deal nearly done, the T-bill curve is sure to rise as the market prices in a wave of issuance to replenish the Treasury’s cash holdings, right? Wrong. 

At pixel time, three-month T-bill yields were down nearly 15 basis points off their weekend highs on perceptions that the feared wave may not materialize: after all, the mooted debt ceiling deal is good for two years, so Treasury doesn’t have to rush. Also, it isn’t clear that it will need or want to run the kind of balance that it had before the latest round of theater. Before the pandemic, it had never been much above $400 billion, and had generally been much lower. The massive amount of liquidity that money market funds are currently sitting on — $5.4 trillion at ICI’s latest count — should likewise put something of a ceiling on T-bill rates. And a $1 trillion valuation for Nvidia, now trading at 23 times expected 2024 sales (no, not earnings, sales) hardly suggests that overall liquidity is particularly tight.

— “I think that in June and July we will have 25 basis point increases in the key rates… Does this happen in September, too? It’s too early to say.” – Gediminas Šimkus, Bank of Lithuania governor, in Vilnius.

— “The assumption is that the ECB is hiking on autopilot, so insightful analysis doesn’t really come into it.” – UBS Wealth Management chief global economist Paul Donovan, morning briefing.

— “I commented yesterday that Turkey has even been using gold reserves to stabilize the currency lately. But when you have limited reserves, it is a temporary measure, by definition.” Exante Data CEO Jens Nordvig, on Twitter.

RECEPE FOR DISASTER: It’s all going Pete Tong for the Turkish lira, now that the elections are over and the Turkish central bank, a.k.a the CBRT, doesn’t have to pretend that locals are cool with another five years of President Recep Tayyip Erdoğan’s unique approach to political economy.

A 2 percent drop in two days may not even register in the lira’s top 10 worst weeks but, as Exante’s Jens Nordvig, quoted above, points out, there’s an expiration date attached to CBRT support: it sold more gold in the last two months than all the world’s other central banks bought. Net FX reserves are now in negative territory for the first time since 2002.

Deutsche Bank analysts said going into the election that “adjustment is likely to materialize” in FX markets after the vote, “with uncertainty surrounding both the scale and speed.”  Which is a way of saying it could be bad, or it could just be freaking nightmarish.

— Why full-reserve banking isn’t a solution to bank failures, writes Frances Coppola on Substack

— Why the Fed is hard to predict, explains Mohamed El-Erian at Project Syndicate. 

— Zurich University’s Michel Habib on how the PBoC ‘guides’ the Chinese markets, (CEPR)

— The dysfunctional taboo: monetary financing at the Bank of England, the Federal Reserve, and the European Central Bank — Provocative (ok, MMTish) stuff from Will Bateman and Jens van’t Klooster  (Taylor & Francis)

THANKS TO: Ben Munster, Johanna Treeck, Anjuli Davies and Bjarke Smith-Meyer.

(Editor’s note: this is intended as a selective list, giving precedence to European events) 

WEDNESDAY, 31 May

— German states’ May CPI data from 7:30 a.m. onward; preliminary German CPI at 2 p.m.

— German April import prices, 8 a.m.

— French April consumer spending 8:45 a.m.

— French May CPI, 8:45 a.m.

— French 1Q GDP revision, 8:45 a.m.

— German May unemployment 09:55 a.m. 

— ECB Financial Stability Review, 10 a.m.

— Italy 1Q GDP revision, 10 a.m.

— Poland May CPI, 10 a.m.

— Poland 1Q GDP revision, 10 a.m.

— ECB’s Visco presents Bank of Italy annual report, 10:30 a.m.

— Italy May CPI 11 a.m.

— MAS’s Ravi Menon speaks at the BIS virtual Green Swan conference, 12:05 p.m. ECB’s Villeroy and BIS’s Carstens speak at 4:30 p.m.

— ECB’s Lagarde to speak to students (no text), 2:30 p.m.

— Fed’s Bowman, Collins to speak, 2:50 p.m.

— U.S. April job openings and labor turnover, 4 p.m.

— SNB’s Jordan to speak, 5 p.m.

— Fed’s Harker to speak, 6:30 p.m.

— Fed’s Jefferson speaks on “Financial Stability and U.S. Economy” at International Conference on Policy Challenges for the Financial Sector, 7:30 p.m.

— Fed issues Beige Book economic survey, 8 p.m.