Credit - Zugzwang

"I have with me two gods, Persuasion and Compulsion." - Themistocles

Watching with interest the escalating tensions between Greece and Germany while a payment was made in favor of "special creditor" IMF, we reminded ourselves, for this week's analogy in our chosen title of a situation called Zugzwang (German for "compulsion to move") found in chess and other games given Greek Finance minister Yanis Varoufakis is an expert in game theory. We found it of special interest because in German chess literature, one player is put at a disadvantage because he must make a move when he would prefer to pass and not to move. The fact that the player is compelled to move means that his position will become significantly weaker. The term is also used in combinatorial game theory, where it means that it directly changes the outcome of the game from a win to a loss. Positions with "zugzwang" occur fairly often in chess endgames, a topic we have discussed in a previous chess analogy surrounding European woes in our conversation "The Game of The Century" where we discussed at the time the great chess master abilities of German Chancellor Angela Merkel :

"By managing to keep Germany’s liabilities unchanged Angela Merkel appears to us as the winner of the latest European summit (number 19...). Question being for us now, can Europe survive in the current form (number of countries) without making material sacrifices in true Bobby Fischer fashion? One has to wonder." - Macronomics, July 2012

As we indicated in our conversation "Eastern promises" on the 9th of June 2012, we think we are clearly approaching the end of the great European "chess" game and ultimately the only possible Nash equilibrium for Germany will be to defect:

"We think the breakup of the European Union could be triggered by Germany, in similar fashion to the demise of the 15 State-Ruble zone in 1994 which was triggered by Russia, its most powerful member which could lead to a smaller European zone. It has been our thoughts which we previously expressed."

The ability to play these endgames well is a major factor distinguishing "masters" from "amateurs". In what was labeled "The Game of the Century" and in reference to our previous 2012 chosen title, Bobby Fischer 13 years old at the time, won the game against Donald Byrne, one of the leading American chess masters, by making material sacrifices at the time. 

On a side note and in continuation to our previous chess reference, the same Bobby Fischer used "Zugzwang" twice against Mark Taimanov in 1971 in the World Championships Candidates match. Mark Taimonov was crushed and lost 6 to zero to Bobby Fischer. The Soviet government was deeply embarrassed, and found it "unthinkable" that he could have lost the match so badly to an American without a "political explanation". In response, Soviet officials took away Taimanov's salary and no longer allowed him to travel overseas. The Soviet government later "forgave" Taimanov, and lifted the sanctions against him following Fischer's 6–0 later win the same year against Danish Bent Larsen known for his "unorthodox" style of play,  which paved the way for Bobby Fischer's achievement in reaching the first World Chess Federation (FIDE) number-one-ranked player. Bobby Fischer held the number one slot for 54 months. Maybe Greek Finance minister Yanis Varoufakis will suffer the same "orthodox" measures than Mark Taimanov, in the short term but we ramble again...

In this week's conversation we will look at France, as from our point of view, it continues to be for us as the new barometer for Euro Risk. We will also continue look at the US earnings picture, which appears to us more and more vulnerable to setbacks thanks to a rapid rising US dollar.

Synopsis:

• France appears to us as the weakest link in Europe at the moment
• Being "short" Euro is one of the most crowded trade
• Europe continues to be a "flow" driven market
• King Dollar even rules the Fed
• Final note "There is an anomaly in US share prices and UST yields"

• France appears to us as the weakest link in Europe at the moment

French politicians are benefiting from low rates on French debt issuance courtesy of on-going "japanification", but, on the economic and political front, France is showing increasing signs of growing stress as pointed out in our last conversation "China syndrome":

"Given France has now postponed any chance of meaningful structural reforms until 2017 with the complicity of the Europe Commission, (again a complete sign of lack of credibility while imposing harsh austerity measures on others), and that the government will face an electoral onslaught in the upcoming local elections which will see yet another significant progress of the French National Front, we are convinced the"Current European equation" will breed more instability and not the safer road longer term."

When it comes to complete credibility failure we have to agree with Louis Capital Market's Cross Asset Strategy note from the 9th of March entitled "Will China Resist America Pressure?" in relation to France's incapacity to reform:

"Last week In France we were amused to hear Pierre Moscovici of the European commission explaining to France that the economic policies implemented up to now were not of a satisfactory or adequate quality. The irony is not lost on us. Moscovici was still France’s Minister of Finance four months ago and a man in charge of deciding and implementing the country’s economic and budget policies. To see four months on telling his ex-boss that policies he most probably was involved in are inadequate is simply farcical.
Finance was promoted to head the world economic decision centre and to explain to countries what kind of reforms they should implement or what kind of macroeconomic policies they should run. In France, the nomination of Christine Lagarde as head of the IMF was seen as another farce.
It is striking to see these days the incapacity of France to adjust its economic policy, and in particular its fiscal policy. The charts below are impressive because they show that in Spain public expenditures have adjusted to the new economic reality of the country whilst in France, the public spending trajectory has not adjusted at all.

The chart below is crystal-clear: the pace of growth of public spending is intact! France and Germany are insistent upon the Greek government to maintain its previously defined fiscal consolidation objective. Yet, France has shown its incapacity to enter any fiscal consolidation. It is a shame to see the lack of effort on the expenditure side in France. However, this subject is of little importance, because confidence is so high in financial markets and because the ECB is financing states for free. The reality is that the ECB refuse to consider that they finance governments – however their actions give them away. With its government bond purchases, the ECB has ensured a low financing cost to investment grade countries, no matter what decision is taken on the budgetary front. The Germans were against QE, because they considered it to be an act similar to lending money for free without counterparties to secure risk. To put it simply their reasoning is true.

France will be the only important country in Europe to see a deterioration of its budget deficit in 2015 compared to 2013. It seems that the French government is betting on the economic recovery to get a cyclical rebound of its revenue that will prevent it from making the painful adjustment on the spending side. The opportunity for France clearly lies in its access to a very low financing cost for its public debt that – mechanically – will lower also its debt service in the budget.
Francois Hollande can send his thanks to Mr Draghi as the current context offers significant opportunities for France. French civil servants would have never accepted a decline in their remuneration as was seen in Southern Europe. These painful decisions have been avoided in France and the government is now ready to boast about the cyclical upswing France is enjoying. Such events leave us speechless." - source Louis Capital Markets

Of course the reason why French civil servants would have never accepted a decline in their remuneration is fairly simple to assess. It is the only support left to French president François Hollande! With only 25% of approval rate, there is indeed a large contingent of public servants still supporting the French president as they represent 22% of the working population versus 11% only in Germany. Please also note that 44% of the French National Assembly is made of public servants which explains the lack of "willingness" in implementing "structural reforms and only 3% of businessmen. In the UK you only find 9% of public servants in the House of Commons and 25% are businessmen. The big difference between the United Kingdom and France is that, in the United Kingdom, the particular problem of public servant eligibility was dealt with an absolute ban by the House of Commons Disqualification Act of 1975 and it was justified on the basis that civil servants should keep their political views a private matter. To do otherwise was deemed to impugn the neutrality of the British public service and its ability to serve government of whatever political persuasion. Civil servants therefore are required in the United Kingdom to resign before announcing their candidature. In France, put it simply, with their "bulletproof" status, they never lose, but, that's another matter...

On that particular point around the impossibility of major reforms, we read with interest Bank of America Merrill Lynch's note on France written by their European Economist Gilles Moec published on the 16th of March and entitled "France: doing more than it seems, but less than is needed":

"Tough fiscal and political equation
For this to be neutral for the fiscal balance, we think such a move should be offset by a reduction in public spending. Actually, Paris needs to do more than a mere offset, since the European institutions are still demanding a net fiscal tightening, in our view. This is where the political rigidities of the French centre-left kick in. Although the current administration has clearly embraced a reformist course, and is ready to confront its increasingly restive left wing minority in parliament, this imposes limits to the government’s room for manoeuvre. The administration needs to carefully choose its battles. The government can - and will - slow down spending, but changing the very structures of the public is out of reach in our view.
Cycle to help
Fortunately, a series of external factors are making the government’s job easier. The drop in oil prices will support consumer spending – which has already showed sign of recovery in the last few months. The decline in the exchange rate of the euro will be a major boost for growth, since the particular sensitivity of French exports to currency gyrations offset the low share of foreign trade in GDP. Still, while this should help keeping Paris on the right side of the European rules, we expect only peripheral progress on structural issues." source Bank of America Merrill Lynch

For the reasons stated above, we have to agree, changing the very structure in public spending is clearly out of reach. The game is not only locked but, it is rigged and the burden of taking France out of the proverbial doldrums has been put on the corporate sector. The issue of course is that the French corporate sector boasts a low and declining profitability thanks to important labor cost as indicated in Bank of America Merrill Lynch's note:

"Faced with low and declining profitability, firms have to choose between three solutions. First, run down headcounts and/or pay until the share of profits in value added is restored. Second, cut down on capital expenditure. Third, maintain headcounts/pay, and capex at the cost of higher debt. In the short run, the third solution is from a collective point of view the best one, since it is the only one which is consistent with some protection of aggregate demand (unless fiscal policy can offset the lack of private demand, at the cost of higher public debt), but obviously this is feasible only if interest rates are sufficiently low and banks have enough appetite to lend. Such option was not open in Spain for instance, where the initial level of corporate debt was high, interest rates were very high on account of the sovereign crisis and banks were not in position to lend. A “crash adjustment” of profitability was the only option (Chart 1)

Among the four largest economies of the Euro area, France is the only country where the investment rate of the non-financial corporate sector in 2008-2014 has exceeded the level of 1999-2007 (Table 2). 

Moreover, the investment effort exceeded gross saving, which is a broader measure of profitability, taking into account the impact of net interest and tax. In 2014, investment exceeded saving by 30% (from 11% in 1999-2007), while in Germany and Spain investment was lower than gross saving (in other words the corporate sector there is in a net lending position) and in Italy recourse to external funding fell (Table 3).

This reflects the resilience of the French banking sector throughout the crisis which was able to meet the demand for credit from the firms. Since Q1 2013, corporate debt as a percentage of corporate output has been is higher in France than in Spain (Chart 2). 

In Q3 2014, the ratio stands at 249% in France, very close to the peak level it had reached in Spain (251% in 2009).

This level of corporate debt is however much more sustainable in France than it ever was in Spain. While in the periphery market rates, and bank interest rates margins shot up during the crisis, imposing a major burden on firms when refinancing their debt, in France the banking sector consented to a major drop in lending rates, while the sovereign bond market was likely never seriously under attack (Chart 3). 

This means that, in spite of the significant increase in the stock of debt, net interest payments have been falling. In Q3 2014, net interests stood at only 4.2% of gross operating surplus, significantly below Spain (Chart 4).

Is there a "zombification risk"?
Still, this can’t be a sustainable growth model, for three reasons. First, even if with QE is ECB has become very credible on the “low for long” interest rates policy stance, interest rates cannot remain below equilibrium in France forever.

Second, companies cannot likely maintain a decent level of capex if their expected profitability does not recover at some point. Third, cheap credit can trigger a process of “zombification” of the corporate sector by keeping fundamentally unsound businesses alive, which down the road would damage growth potential by keeping resources skewed towards the least productive sectors.

In France the number of corporate bankruptcies never exceeded the 1993 peak. This contrasts with the explosion in corporate failures seen in Spain (Chart 5 and Chart 6). 

One could find comfort in the fact that the pace of business failure is in line with the position in the cycle, but this could be a case of reverse causality: the reason why the French output gap is not deeper could simply come from the fact that businesses are allowed to survive by an overly complacent banking sector.
However, since the French productivity performance has been decent lately - when compared with Germany - we think that the high survival rate of French companies has not yet impacted overall economic performance, but it's a risk for the future."  - source Bank of America Merrill Lynch

While the corporate sector has been clearly preserved compared to Spain from lower leverage and a lesser credit crunch, the corporate sector, in our views cannot continue to do the "heavy lifting" when public expenses continue to represent around 58% of GDP. Furthermore as it can be seen in Chart 2 from Bank of America Merrill Lynch, the French Corporate debt over corporate output has been steadily increasing and is now above Spain which has been rapidly deleveraging during the last few years.

The political issue of course is that in the incoming elections, the French socialist party is facing serious bashing and as we mentioned before, it's only support comes from the public sector employees as also underlined by Bank of America Merrill Lynch's note:

"This gradualist approach – which generates a pervasive sense in the foreign commentariat that “France is not doing anything” – reflects in our view the fact that i) the current administration campaigned in 2012 on a rejection of Sarkozy’s stance, seen as “too brutal” and ii) an increasingly restive traditionalist left wing of the socialist party imposes limits to the reforms.
Indeed, a peculiarity of the socialist party is that the core of its support does not come from the working class employed in the private sector (which has been increasingly deserting the left for the National Front) but public sector employees.

This puts a limit to how far the government can go in any structural overhaul of how the state operates, while the reformist turnaround of Hollande has created a wedge in the socialist party's parliamentary group.

The fairly limited deregulation offered by the “loi Macron” was forced through parliament thanks to the 49.3 procedure, which explicitly links the passing of a bill to the survival of the government. The left wing of the socialist party had no choice but to support the government on this, to avoid early elections in which they would probably have been wiped out.

The 49.3 procedure can be used only once in each parliamentary session (although the budget bill is excluded from this limit, which means that the government can almost certainly get a budget through). This means that the government must now choose its battles carefully" - source Bank of America Merrill Lynch

While the international scene is watching with caution the rise of the French National Front, the political story, we think is the slow dislocation of the unity of the left. Statistically speaking, what has been rising is more the number of non-voters (around 60%), rather than the "absolute" number of people voting for the National Front.

But, let's move back to France and its "micro-economic" picture. In our conversation "The European crisis: The Greatest Show on Earth", we indicated:

"When it comes to credit conditions in Europe, not only do we closely monitor the ECB lending surveys, we also monitor on a monthly basis the “Association Française des Trésoriers d’Entreprise” (French Corporate Treasurers Association) surveys."

One particular important indicator we follow is the rise in Terms of Payment as reported by French corporate treasurers. The latest survey published on the 13th of March points to a deterioration in the Terms of Payments, which indicates that the improving trend since mid 2012 has turned decisively negative:

The monthly question asked to French Corporate Treasurers is as follows:

Do the delays in receiving payments from your clients tend to fall, remain stable or rise?

Delays in "Terms of Payment" as indicated in their March survey have reported an increase by corporate treasurers. Overall +17.9% of corporate treasurers reported an increase compared to the previous month (+13.9%), bringing it back to the level reached in October 2014 (17.9%). The record in 2008 was 40%.

Overall, according to the same monthly survey from the AFTE, large French corporate treasurers indicated that they are still facing an increase in delays in getting paid by their clients. It is therefore not a surprise to see that the overall cash position of French Corporate Treasurers which had been on an improving trend since 2011 has now turned more negative overall according to the survey:

The monthly question asked to French Corporate Treasurers is as follows:

"Is your overall cash position compared to last month falling, remains stable or rising?"

Whereas the balance for positive opinions was 17.9% in November 2014 and still at 6.3% in January 2015, February saw it dip to -5.2% and March's provisional figure came at -8.5%. 

This warrants significant monitoring in the coming months we think from a "corporate monitoring health" perspective.

• Being "short" Euro is one of the most crowded trade

According to Nomura's FX Positioning Index from the 13th of March, short Euro positioning is still close to record high of November but, looks like it close to stabilising: 

"EUR positioning was little changed the week ended Tuesday, falling just $0.1bn. Since then, specs have sold a further $1.7bn. Positioning is estimated currently at -$25.9bn which is still shy of the lows from November (-$28.1bn) and February (-$28.2bn)."

 - source Nomura

The very significant rapid depreciation of the Euro in conjunction with record low yields are for us clearly signs of the on-going "japanification" process at play in Europe and validates our deflationary bias. But, in terms of risk reversal for the Euro, there could be a pause depending on the FOMC outcome we think.   

In terms of bond yields as well we are getting closer to some floor in Europe (except for Greece...). On that specific "bond" matter we agree with Louis Capital Markets take:

"We have been OW bonds for a while, but would be back to a neutral position because the upside/downside likelihood appears more balanced now. As Mr Weidmann from the ECB said, if the implementation of QE by the ECB is a success, nominal bond yields will increase in the end. This is indeed our conviction and the charts below explain the reasons why.

The green line above should creep higher as inflation expectations normalise. Indeed, the above chart on the right shows that current real yields (extracted from long term inflation linked bonds) are extremely low in Europe (well below the level reached by US inflation linked bonds during QE3). There should, therefore, be a limit to the downside of real rates in Europe which in the end implies a limit to the downside of nominal bond yields in Europe.

We would also like to add to what Mr Weidmann said that if QE is successful, bonds yields should rise AND the euro should stabilise or rise.
This is the contradiction that is emerging these days among investors: if investors continue to be short on the euro, they cannot continue buying European equities, because if the euro continues to decline it will reflect the failure of QE and will validate a deflationary scenario for Europe.
Therefore, the next phase is to see the stabilisation of the euro to validate the recovery of the growth expectations in Europe." - source Louis Capital Markets

When it comes to the success of QE in Europe, as we have stated before, QE without additional policies is bound to fail. 

While from a flow perspective we believe in short term stabilization of the Euro, we agree that the continuation of the decline of the Euro will indeed ultimately reflect the failure of QE and the deflationary scenario playing out in Europe à la Japan.

• Europe continues to be a "flow" driven market

As far as European equities are concerned, it is indeed a flow driven market which has seen strong foreign investments, particularly by Japanese investors as indicated by Nomura in their JPY Intraday Comment from the 12th of March entitled "Strong foreign equity buying continues":

"Strong foreign equity buying continues
Japanese investors continued to purchase foreign assets at a high pace last week.
They bought JPY356bn ($3.0bn) of foreign equities, for the sixteenth week in a row, while purchasing JPY270bn ($2.3bn) of foreign bonds, for the seventh consecutive week (Figure 1).

Foreign equity investment flows remain strong, with net purchases of over
JPY1trn per month (Figure 2). 

Japanese investors purchased JPY1384bn ($11.5bn) of foreign equities in February, more than JPY1trn for the third consecutive month . The record pace of Japanese investment in foreign equities continues so far in March. Pension funds and retail investors were two major net buyers of foreign equities recently, and we expect them to remain strong net buyers of foreign equities as public pension funds shift their portfolios from JGBs and better economic conditions support risk sentiment among retail investors. Strong foreign equity investment by Japanese investors should support USD/JPY this year.

Foreign bond investment has also been relatively strong, while February’s MOFdata showed that banks were major buyers of foreign bonds. Their foreign bond investment likely involved smaller FX transactions than other investor types. Pension funds and toshin companies were also likely small net buyers of foreign bonds, while life insurance companies may still be quiet ahead of fiscal year-end. Life insurance companies sold foreign bonds in February for the first time in two months, albeit a small amount." - source Nomura

The Ides of March...or when Japanese investors are "Zugzwang" (compelled to invest) before the end of the fiscal year (31st of March).

According to Nomura's report,  there was net buying of JPY31bn (USD255mn) in foreign currency denominated toshins on 10 March, according to NRI, the 56th consecutive business day of net purchases. We continue to closely look at Japanese flows when it comes to their European appetite.

• King Dollar even rules the Fed

Meanwhile the USD crowd remains near record high according to Nomura's FX Positioning Index from the 13th of March:

"According to the IMM data for the week ended March 10, non-commercial accounts increased their USD longs by $3.9bn. Our real time indicator suggests net longs increased by a further $1.2bn since. Net longs stood at $52.8bn by Tuesday and had increased to $54.0bn by Friday’s close, just shy of the all-time high of $55.6bn set the second week of January." 

- source Nomura

We do not believe in a June hike by the Fed and are adamant the Fed will remain rather dovish in the light of recent data disappointments regardless of the strong NFP data recently released. We are therefore content with our current long duration exposure which we added on recently.

On that point we agree with Nomura's latest take from their 13th of March note entitled "Fed - behind the curve or just right?":

"Cross Rates View
The start of the ECB bond-buying spree this week resulted in a further push to historical low yields in Germany, with Bunds breaking through the 20 bps barrier. Almost like clockwork, the UST auctions went over well as the overall EU curve flattening helped reverse the NFP-led selloff. Heading into FOMC next week, it will be another meeting in which they guide the market’s expectations that hiking will happen only when all factors give them enough confidence to do so later this year. The market has had a tendency recently to go into FOMC/Minutes expecting a hawkish event only to be let down. We think the recent reaction to such Fed events will be repeated next week, with the market adding to hedges ahead of time and unwinding them during the presser." - source Nomura

King Dollar: One currency to rule them all, even the Fed!

"Pace: Faster hikes should be self-restrained by an increasingly stronger USD

So far the pricing for a June hike has been a lot more uncertain compared with the 2004 cycle (Fig. 5),  and the Fed’s hiking pace is even more difficult to pinpoint—it should be anything but the well-telegraphed 25bp per meeting schedule we saw back in 2004. 

One key driver this time around is the total dichotomy of global monetary policy, wherein the Fed is about to embark on a hiking path, while the second-largest economic bloc, i.e., the Eurozone, has just started its easing program, while the BoJ is still in QQE. As a result, the FX adjustment is going to have a much more pronounced impact (Fig. 6) on both the financial markets and the U.S. economy. 

We are already seeing equity markets under a bit of pressure as the stronger dollar eats into corporate profits, especially given the heavy weighting of multinationals in the broader indices. As the effects of a stronger dollar trickle down to worsening trade and softer inflation prints, we expect the Fed to be very gentle, as a faster hike pace will have a compounded effect via FX tightening."

Terminal Rate – Higher debt loads call for a terminal rate much lower than before

The business cycle/equity rally is long in the tooth; and with other central banks easing while taper and the dollar act as tightening forces, the terminal rate will end up lower than in the past. The Fed has been ratcheting down terminal expectations (from 4.25% to 3.75%), but we believe that in the upcoming meetings it will avoid lowering this as much as the other dots. Instead we see it focusing more on lowering the dots in 2015 and 2016, because it doesn’t want to admit defeat just yet. Meanwhile, our Economics Team believes the terminal level will be closer to 3% when the Fed finishes tightening in this cycle, largely due to the dollar, as noted above (see link). We stated that the Fed will be lucky to get to 2-2.5% when all is said and done, largely because ratcheting up aggregate demand while performing debt deleveraging requires years of low real rates." - source Nomura

Exactly!
The large global debt overhang requires much smoother maneuvering from the Fed thanks to King Dollar although the Fed feels it needs "Zugzwang" due to latest employment data.

On the dichotomy between Economists' perception and consumers' reality we completely agree with Reorient Group David Goldman's take in their note from the 15th of March entitled "It's all about the dollar...even for the Fed":

"The fact is that consumer behavior with respect to gasoline purchases is not much different than with respect to other items in the consumption basket. The chart below shows year-on-year change in nominal purchases of all goods (excluding food services) and gasoline. The two lines have the identical shape; the only difference is that the absolute change in gasoline sales is much greater, reflecting the volatility of the gasoline price. Evidently American consumers do not feel as confident about the employment outlook as the economists. We observed last week that most of the new jobs created during the employment bounce of the past three months were in low-wage, labor-intensive industries (health care, hospitality, and retail), which explains why wage growth has been absent.

We have never been enthusiastic about quantitative easing: the drag on the US economy is regulatory and fiscal rather than monetary, and the Federal Reserve has had the unenviable task of promoting growth against these headwinds. But the prevailing view at the Fed that an economic rebound justifies higher rates—seemingly among the whole Board of Governors except for Chair Janet Yellen—is inconsistent with the data. The bond market has remained skeptical. The present 10-year Treasury yield of just over 2% reflects lower inflation expectations, consistent with falling commodities prices, and a modestly higher “real” rate (the yield on inflation-indexed securities)." - source Reorient Group, David Goldman

While the Board of Governors of the Fed might feel the "Zugzwang" urge, we remind ourselves that the fact that these players feel compelled to move means that their position will ultimately become significantly weaker. If their head prevails, at the FOMC, they will remain on hold and delay hiking interest rates in June until further data validates the "Zugzwang" we think.

• Final note "There is an anomaly in US share prices and UST yields"

Like many pundits, we believe the velocity of the rise in King Dollar represents a significant headwind for US corporate earnings and yet another important factor for the eager to trigger "Zugzwang" Fed. In that instance we read with interest Nomura's Japan Navigator comments from the 16th of March. US corporate earnings in April will be essential to watch!

"Concerns over US corporate earnings reports in April
Since last summer, we have been pointing out the anomaly in US share prices and UST yields that appeared at the start of the quarter, which remains in place (Figure 3). 

 This anomaly is: 1) overvalued stock prices correct before earnings season starts, which has been typical in recent quarters; and, 2) The Fed conducts policy based on its communications with the market, and adjusts its hawkishness depending on stock market conditions, which also drives movements in rates markets. Currently, the impact from strong USD on corporate earnings is a key theme, which should increase investor concerns over earnings announcements.

We believe the Fed will remove the “patient” wording in its next statement, but this alone is unlikely to change rate hike expectations. However, as this would means the Fed is maintaining its hawkish stance, investor risk sentiment should then deteriorate into next month’s corporate earnings reports.
Given this, it is worth considering a risk scenario in which the Fed sends an unexpectedly dovish message at its next meeting. While this would likely prompt bond yields to fall, risk sentiment could improve, laying the groundwork for higher share prices and bond yields in April-June.
In either case, this would not trigger the next upturn in yields, unless US economic indicators surprise on the upside." - source Nomura

So "bad news" (rate hike) could end up being good news for US Long bond holders like ourselves (holding pattern). After all that's exactly what we pointed out in the first bullet point of our conversation "Information cascade":

"Under a dovish monetary global policy, both stock and bond markets will strengthen concurrently." - source Macronomics, 8th of March 2015

"What makes zugzwang such a painful death is that the deceased is executed not by a threat but by his own suicide" - Andrew Eden Soltis, American chess grandmaster.

Stay tuned!

Credit - Stimulant psychosis

"Every form of addiction is bad, no matter whether the narcotic be alcohol or morphine or idealism." - Carl Jung

Watching with interest our "Generous Gambler" aka Mario Draghi finally firing his "Chekhov's gun" and unleashing QE in Europe, pushing in effect more government bonds towards negative yields, we reminded ourselves, when choosing this week's analogy for our title of a specific kind of psychotic disorder called "Stimulant psychosis" that occurs in some people who use stimulant drugs:

"Stimulant psychosis commonly occurs in people who abuse stimulants, but it also occurs in some patients taking therapeutic doses of stimulant drugs under medical supervision." - source Wikipedia

While the symptoms of stimulant psychosis may vary slightly depending on the drug ingested, it generally include the symptoms of organic psychosis including hallucinations, delusions, thought disorder, and, in extreme cases, catatonia. We can already see in the MSM (Mainstream media) and in most of the comments from the European political "elite" symptoms of hallucinations, delusions and of course thought disorder of the highest order but we ramble again...

As a reminder of our conversation "Pascal's Wager" from October 2014, we pointed out the strength of the deflationary forces at play:

"In terms of the implication for Europe (as discussed in the "Coffin Corner"), the aggressiveness of the Japanese reflationary stance spells indeed more deflation for Europe, unless the ECB of course decides to engage as well in a QE of its own:
"Moving on to Europe, we are unfortunately pretty confident about our deflationary call in Europe, particularly using an analogy of tectonic plates. Europe was facing one tectonic plate, the US, now two with Japan. It spells deflation bust in Europe unless ECB steps in as well we think." - Macronomics - 27th of April 2013."

Of course in this week's conversation, we would like to review the supposed impact of what QE will bring to Europe, and we would like to point out the implications of the unleashing of the "Chekhov's gun by our "Generous Gambler" and the major difference between QE in Europe versus QE in the US, because once again the Devil is indeed in the details. 

Synopsis:

• The ECB has become the world's fastest QE gunslinger!
•  Rentiers seek and prefer deflation - European QE to benefit US Investment Grade credit investors.
• The on-going "Stimulant psychosis" experience led by our central banks deities is leading to more pronounced "Cantillon Effects" aka asset price inflation on a grand scale.
• In similar fashion to what we wrote about Japan in general and credit versus equities in particular in our April 2012 conversation "Deleveraging - Bad for equities but good for credit assets"
• The result of course is that the unquenchable hunt for yield is not only pushing investors towards the higher quality spectrum but also extending duration exposure
• When it comes to the "euthanasia of the rentier", what our central bankers deities are not realizing is that capital with ZIRP is not being deployed but merely destroyed
• We would like to re-iterate, investors shorting US Treasuries will continue to be punished!
•  European QE, the Devil is the detail and the future of the Euro lies in Germany's liability exposure

Talking about the Devil, it reminds us as well of the quote we used back in September 2014 in our conversation "Sympathy for the Devil":

"The greatest trick European central bankers ever pulled was to convince the world that default risk didn't exist" - Macronomics.

In fact in our previous conversation we indicated the following:

"Investors have indeed Sympathy for the Devil we think, as they continue to pile up with much abandon and more and more getting "carried away" in their insatiable hunt for yield. In that sense Baudelaire's 1869 poem rings eerily familiar with the current investment situation in the sense that investors have been giving our "Generous Gambler" the benefit of the doubt (OMT - and now full blown QE) and shown their sympathy and their blind beliefs in "implicit" guarantees, rather than "explicit" (such as the German Constitution as we argued in various conversations):
"If it hadn't been for the fear of humiliating myself before such a grand assembly, I would willingly have fallen at the feet of this generous gambler, to thank him for his unheard of munificence. But little by little, after I left him, incurable mistrust returned to my breast. I no longer dared to believe in such prodigious good fortune, and, as I went to bed, saying my prayers out of the remnants of imbecilic habit, I said, half-asleep: "My God! Lord, my God! Please make the devil keep his word!"
But as years have gone by in the European tragedy, we have become somewhat immunized from our great magician's spells. Many investors have indeed shown the greatest sympathy in respect to piling up on European Government Debt in the process, while banks have been shedding assets leading to outright credit contractions leading in the past two years European banks to cut their lending to businesses by about 8.5 per cent." - source Macronomics, 9th of September 2014

• The ECB has become the world's fastest QE gunslinger!

While we pointed out in our conversation "Chekhov's gun" that the BOJ and the FED had been QE fast drawers with the SNB front running aggressively the ECB as of late, as pointed out by Bank of America Merrill Lynch European Credit Strategist note from the 23rd of January entitled "QE Sera, Sera", the ECB has become the fastest gunslinger around:

"And so it begins…
The dawn of QE in Europe. Yesterday’s ECB meeting lived up to expectations, plus more. The central bank unveiled asset purchases of €60bn a month across Eurozone sovereign, agency, covered and asset-backed bonds. Banks were boosted by the TLTRO being made cheaper and thus more tempting. But the biggest victory for Draghi, in our view, was the open-ended feel that he was able to convey towards the programme.
Risk assets gave the ECB a vote of confidence by the end of the day, and understandably so – the ECB will likely now have the fastest growing balance sheet across the globe (chart 1). 

Stocks finished up yesterday, sub banks rallied and high-yield tightened. CCCs in particular were very strong, up 2-3pts, the first time in a number of months that the asset class has seen a big move.

But what of credit?

For credit investors, there was no pledge to buy corporate bonds. We had wondered whether the ECB might “tag on” corporate purchases just to make their asset gathering process easier. The dream could still live on if the ECB struggle to buy €60bn a month (note our rates team’s net Eurozone government bond issuance forecast of only €275bn this year). But for now, credit will not be bought.

Yet, there were few signs of weakness, or knee-jerk moves wider in corporate bonds yesterday. If anything, the need for income remains as intense as ever in Europe, with the backdrop of huge amounts of negative yielding government debt (chart 3), and note that the Danish Central bank lowered its deposit rate yesterday (the second cut in a week!). 

The race below zero by central banks is in full force, and so is the movement of money “up the value chain” in search of positive returns. Credit should benefit tremendously from this over time, we think.

The ECB is also becoming a prolific asset gatherer just at a time when financing needs, generally, are in decline. Sovereign funding needs have shrunk as budget deficits have reduced, bank funding needs have also dwindled amid deleveraging and the ECB’s focus on rejuvenating the loan market will mean less corporate supply over time, especially in high-yield (note SME lending rates are falling quickly now, chart 2).

 Chart 4 shows the net supply of fixed-income instruments in Europe on a yearly basis (we use sovereign debt, covered, senior banks and quasi-sovereigns), versus the net growth in the ECB’s balance sheet.

The bottom line is that the ECB is expanding its balance sheet just at a time when assets are being produced at a slower rate. As central banks exacerbate the demand/supply imbalance in asset markets, we see this as a backdrop for prices generally to rise, and by extension – credit spreads to rally." - source Bank of America Merrill Lynch

Of course we agree with the above when it comes to the value proposition of credit in Europe thanks to the on-going "japanification" process, with the slow "euthanasia of the rentier" to paraphrase Keynes from his 1936 "General Theory" book. On that subject we read with interest Andrew McKillop's January 2013 article entitled "Keynes Said: Euthanize The Rentiers, Instead We Euthanized The Economy":

"The bases of the French Revolution of 1789 had been set because even at that time, rentiers were struggling to defend the purchasing power of their interest income and at least preserve the capital value of their wealth. This put them in open conflict with the "traditional rentiers" of the monarchy, nobility, religious orders, and a few other players, who for political survival engaged in creating new and allied rentiers, giving them what French call "une rente de situation" for their personal political benefit, as well as personal financial or economic benefit. This was nothing to do with the national interest, it almost goes without saying.
Inflation is the first enemy of the rentier, but was also the friend of the state - basically the monarchy - in France throughout the 18th century. The very first "asset bubble" organized for and on behalf of the French monarchy by Scotsman John Law, before 1720, the Mississippi Company bubble, was aimed at destroying the real cost of debt owed by the monarchy and its associated nobility, to "the rentiers". Law's action, a Ponzi-type scam, had overkill effects. Some historians argue this first modern asset bubble, aimed at firstly inflating paper asset values, exchanging them against debt owed by the monarchy to rentiers, and then collapsing the bubble helped sow the seeds of the 1789 revolution through decades-long unwillingness of "the rentiers" to lend, after this asset implosion.
Rentiers seek and prefer deflation. They prefer conservative government policies of balanced budgets and deflationary conditions, even at the expense of economic growth, capital accumulation and high levels of employment. As early as 1820, this was a major theme of David Ricardo. Today, especially in Japan, it is intense daily action by the state and its central bank, seeking by all means to create inflation because "when there is inflation, the economy is still alive", and of course the cost of debt in real terms will fall.
This underlines the fatal flaw in Keynesian-type economics: high inflation, and-or extremely low or zero interest rates, "for prime borrowers", firstly needs rentiers to supply the capital to borrow. Before that, the capital has to be formed or accumulated. If both processes are unsure, uncertain, or inoperative the result can only be economic decline.
The problem today is starkly simple. Without massive money printing and issue, the dearth of capital would be so striking that the New Poverty of the world would be impossible to ignore. The global banking system, at latest since 2008, has vastly overvalued collateral or "assets", and a long-term basic trend, intensifying since 2008 of deflating balance sheets. Governments of all major OECD countries with a combined GDP of about one-half of the world's total output, through their central banks, are each day back-stopping the banks, which are insolvent institutions, flooding them with sovereign debt and fiat money, and manipulating credit markets to maintain apparent valuations.
THE NEW POVERTY OF NATIONS
Without this "window dressing", the reality is that the private sector economy is still contracting four years after the credit bubble burst. It is only concealed by the expansion of government spending and fiat money issue. Governments possibly do not understand they are in the midst of an economic collapse and will be the last to admit it, but as in previous epic struggles between the vested interests in play in a society and its economy, for example in the run-up to the French Revolution, the manipulation of credit, values, money and prices has made it impossible to accurately monitor the economy." - source  Andrew McKillop

When it comes to our contrarian take on US yields since early January 2014 we argued the following in our conversation "Supervaluationism" back in May 2014 it comes from us agreeing with Antal Fekete's take from his paper "Bonds Defy Dire Forecasts but they are not defying logic":

"The behavior of the bond market has been consistent with Keynesianism. By his compassionate phrase “euthanasia of the rentier” Keynes meant the reduction of the rate of interest, to zero if need be, as part of the official monetary policy to deprive the coupon-clipping class of its “unearned” income. Perhaps it is not a waste of time to repeat my argument why, in following Keynes’ recipe, the Fed is acting contrary to purpose. While wanting to induce inflation, it induces deflation.The main tenet of Keynesianism is that the government has the power to manipulate interest rates as it pleases, in order to keep unemployment in check. Keynes argued that the free market economy was unstable as it was open to the swings of irrational investor optimism or pessimism that would result in unpredictable and wild fluctuation of output, employment and prices. Wise politicians guided by brilliant economists − such as, first and foremost, himself  −  had to have the power “to prime the pump” (read: to pump up the money supply) as well as the power to “fine-tune” (read: to suppress) the rate of interest. They had to have these powers to induce the right amount of spending needed to put people to work, to entice entrepreneurs with ‘teaser interest rates’ to go ahead with projects they would otherwise hesitate to undertake. Above all, politicians had to have the power to unbalance the budget in order to be able to help themselves to unlimited funds to spend on public works, in case private enterprise still failed to come through with the money.However, Keynes completely ignored the constraints of finance, including the elementary fact that ex nihilo nihil fit (nothing comes from nothing). In particular, he ignored the fact that there is obstruction to suppressing the rate of interest (namely, the rising of the bond price beyond all bounds) and, likewise, there is obstruction to suppressing the bond price (namely, the rising of the rate of interest beyond all bounds). Thus, then, while Keynes was hell-bent on impounding the “unearned” interest income of the “parasitic” rentiers with his left hand, he would inadvertently grant unprecedented capital gains to them in the form of exorbitant bond price with his right." - Antal Fekete

•  Rentiers seek and prefer deflation - European QE to benefit US Investment Grade credit investors.

In our October conversation "Actus Tragicus" we disagreed with Bank of America Merrill Lynch' s credit team in their Credit Market Strategist note from the 10th of October entitled "Breaking up is so easy to do":

"We find it unlikely that the existence of big global yield differentials will accelerate inflows to US fixed income for two reasons. First, while we would indeed expect inflows in a high return environment of both high and declining US yields, with rising US interest rates – which our interest rate strategists expect – returns are much less attractive, despite the higher yields. Second, there appears to be little mean-reversion in interest rate differentials – at least between US and German interest rates." - source Bank of America Merrill Lynch

We correctly argued at the time:

"We therefore do think (and so far flows in US investment grade are validating this move) that interest rate differential will indeed accelerate inflows towards US fixed income, contrary to Bank of America Merrill Lynch's views. We do not expect a rapid rise in US interest rates but a continuation of the flattening of the US yield curve and a continuation in US 10 year and 30 year yield compression and therefore performance, meaning an extension in credit and duration exposure of investors towards US investment grade as per the "Global Credit Channel Clock" (although the releveraging of US corporates means it is getting more and more late in the credit game...)."

"When the facts change, I change my mind. What do you do, sir? - Sir John Maynard Keynes

 What is of interest is that, when the facts change, Bank of America Merrill Lynch do change their mind given that in their latest Credit Market Strategist note from the 23rd of January 2015 entitled "All but corporate bonds" they argued the following:

"US IG credit benefits from the ECB action as investors are sent our way. First, the greater than expected expansion of the ECB’s balance sheet implies that for non-official European fixed income investors the investment opportunity set shrinks. The effect is that more European investors will be forced into US IG. Second, while the absence corporate bond purchases removes the potential for a big move tighter in spreads, in the short term certain sectors in US credit could benefit as investors unwind their expressed views that the ECB would buy corporate bonds. For example an investor that wanted exposure to a certain name that had both EUR and USD bonds outstanding might have been willing to give up spread by buying the EUR bond, in order to profit more from an ECB corporate bond buying announcement. Now with that upside potential eliminated the investor may rationally swap to the generally more attractive credit spreads offered in USD tranches."

- source Bank of America Merrill Lynch

• The on-going "Stimulant psychosis" experience led by our central banks deities is leading to more pronounced "Cantillon Effects" aka asset price inflation on a grand scale.

As we posited in our conversation "Pascal's Wager":

"The only "rational" explanation coming from the impressive surge in asset prices (stocks, art, classic cars, etc.) courtesy of QEs and monetary base expansion has been to choose (B), belief that indeed, our central bankers are "Gods"."

To further illustrate the "inflationary" bias of current monetary policies on asset price bubbles coinciding with "exogenous" (central banks) monetary policy, apart from the Art market, one could simply look at the price evolution of "classic cars" clearly indicative of "pure" Cantillon Effects (detached from the capital structure). To that effect and courtesy of United Kingdom Classic Cars magazine  please find enclosed a good illustration of this "effect" on the price evolution of a Citroën DS classic car:

- source Classic Cars Magazine

• In similar fashion to what we wrote about Japan in general and credit versus equities in particular in our April 2012 conversation "Deleveraging - Bad for equities but good for credit assets":

"Financial credit may be the next big opportunity

The build-up of corporate leverage in the 2000s was confined to financials which, unlike other corporates, had escaped unscarred from the 2001 experience. However, this changed in 2008. Judging by the experience of G3 (US, EU, Japan) non-financial corporates, there should be significant deleveraging in banks going forward. Indeed, regulatory pressures are also pushing in that direction. All else being equal, this should be bullish for financial credit." - source Nomura

This is what we wrote in June 2014 in our conversation "Deus Deceptor" when it comes to the value proposition of investment grade credit we discussed as well in "Quality Street":

"The "japanification" process in the government bond space continues to support the bid for credit, with the caveat that for the investment grade class, there is no more interest rate buffer meaning investors are "obliged" to take risks outside their comfort zone (in untested areas such as CoCos - contingent convertibles financials bonds)."

• The result of course is that the unquenchable hunt for yield is not only pushing investors towards the higher quality spectrum but, also extending duration exposure:

The result of course is that the unquenchable hunt for yield is not only pushing investors towards the higher quality spectrum which is in great demand as indicated by the additional +$1.2 billion in Investment Grade inflows in the week ending on the 21st of January versus -$445 million of outflows in High Yield, but, it is also leading to duration extension as indicated by Bank of America Merrill Lynch's chart from their recent Follow the Flow note from the 23rd of January entitled "It's Europe time":

"Quality yield and some growth down the line?
Pre-ECB, the big flows were into European equities, with the expectation that monetary policy will lead to stronger growth down the line. Equity funds saw a $2.3bn inflow, the largest since June last year while the inflow into equity ETFs was the strongest since May’12.
Income remained a dominant theme: investment-grade registered its 57th straight week of inflows. Money market funds have also seen 4 straight weeks of inflows – the best streak since mid-2013 – as negative deposit rates force money “up the value chain”.
High-yield has yet to get a boost from the income theme though: the asset class saw small outflows of $445m over the last week, and has seen $2.4bn outflows YTD.
European commodity funds recorded their biggest inflow ever, with oil stabilizing and with the bid for gold in the wake of the SNB rate cut. EM debt suffered another weekly outflow, the seventh in a row."

- source Bank of America Merrill Lynch

• When it comes to the "euthanasia of the rentier", what our central bankers deities are not realizing is that capital with ZIRP is not being deployed but merely destroyed as we have argued in our conversation of November 2012, "The Omnipotence Paradox":

"Fixed Income, Floating Expenses...We are more concerned about the "Profits Cliff" or "Peak margins" effect given that companies can't figure how to make use of their cash hence the flurry of buy-backs which we greatly dislike. Indeed, the "unintended consequences" of the zero rate boundaries being tackled by our "omnipotent" central banks "deities" is that capital is no longer being deployed but destroyed (buy-backs being a good indicator of the lack of investment perspectives)"

 As illustration of the destruction of capital and the supposed recovery in the US, we would like to point to a small conversation our Macronomics fellow blogger and good cross-asset friend "Sormiou" had with a US derivatives sell-side practitioner on the micro news on the employment front:

"Sormiou": “In less than a week in the US:   SLB (-7k jobs/ 7% workforce)  / BHI (-9k, 12%) / EBAY (-4k / 7%) / AmEXpress (-4k, -8%) Oil sector of course, but not only.   We are  hearing the "wage growth / employment pick-up" consensus argument from many sell-side strategists, but on the micro front, things do not look as rosy to us, even though a few announcements do not make a trend yet... thoughts?”

Him: “First is on the macro level = Yellen (and other doves) have flagged, under-employment is still much too high.  the U6 number (USUDMAER in Bloomberg) is still 11.2% vs 8% pre-crisis.  The U6 is a measure of the unemployed and the "under" employed-those folks who want full time, but can only get part time...as well as people who have been unemployed for so long they have fallen off the headline U3 number of 5.6%.  In fact, underemployment has been a major argument for postponing rate rise by the doves.  Point here is I think you are exactly correct in digging -the U3 headline number of 5.6% is absolutely not telling the entire story! More worrying maybe is the unemployment rate dissected across demographics. Unemployment among US youth is shockingly high.

Second is on a company level as you have flagged. Much of the earnings growth over the past few years can be attributed to cost cutting rather than organic growth to operating income.  Once costs were more "in control" for some companies, they turned to M&A to help generate returns - again to increase / boost slack organic operating income growth.  This earning period I think will certainly be more interesting than the last few because there is only so long you can mask sluggish organic growth...and we are seeing it in a few names that have reported.  In general, earnings are coming in 50bps below estimates (according to FactSet numbers).  Granted, we are still early in the earning cycle so too early to call...but if M&A doesn't get you what you need via a bolt on...and organic growth is still lackluster then the only thing to do is turn to is costs again - which is what I think we are seeing (and what you have flagged).”

Could companies focusing on costs again be the reason on why US Weekly jobless claims in the US are remaining above 300K for the third straight week? This is indeed a point to closely monitor we think, going forward.

• We would like to re-iterate, investors shorting US Treasuries will continue to be punished!

We would like to re-iterate why investors shorting US Treasuries will continue to be punished because they do not understand the game being played, On that specific matter we will simply quote again Antal Fekete from our July 2014 conversation entitled "Perpetual Motion":

"Moving back to the important notion of the difference between stocks and flows we do agree with Antal Fekete's take in May 2010 in his article "Hyperinflation or Hyperdeflation" being akin to a Black Hole and the possibility of capital being destroyed thanks to ZIRP (as it is mis-allocated towards speculative endeavors) hence the risk of pushing to far the "Perpetual Motion" experience":
"Obviously, you need a theory to explain what is happening other than the QTM. I have offered such a theory. I have called it the Black Hole of Zero Interest. When the Federal Reserve (the Fed) is pushing the rate of interest down to zero (insofar as it needs pushing), wholesale destruction of capital is taking place unobtrusively but none the less effectively. Deflation is the measure of wealth in the process of self-destruction -- wealth gone for good. The Fed is pouring oil on the fire as it is trying to push long-term rates down after it has succeeded in pushing short term rates to zero. It merely makes more wealth self-destruct, and it makes the pull of the Black Hole irresistible.But why is it that the inordinate money creation by the Fed is having no lasting effect on prices? It is because the Fed can create all the money it wants, but it cannot command it to flow uphill. The new money flows downhill where the fun is: to the bond market. Bond speculators are having a field day. Their bets are on the house: if they lose, the losses will be picked up by the public purse. But why does the Fed under-write the losses of the bond speculators? What we see is a gigantic Ponzi scheme. The Treasury issues the bonds by the trillions, and promises huge risk-free profits to the bond speculators in order to induce them to buy. Most speculators believe that the Treasury is not bluffing and they buy. Some may believe that the Fed is falsecarding doubts and they sell. But every time they do they only see foregone profits. What we have here is a rare symbiotic relation between the government and the speculators." - Antal Fekete

•  European QE, the Devil is the detail and the future of the Euro lies in Germany's liability exposure

In relation to the European QE and the details of the "plan", we would like to quote our good friend and former colleague Anthony Peters, strategist at SwissInvest and regularly featured in IFR from his last post entitled  "On the ECB and mutualisation of risk":

"Yes, I did take time off the desk yesterday afternoon to listen to St Mario's press conference. I heard everything he said and but I didn't understand quite a lot of it. Going into it, I had had a long talk with Ian McBride of Mirexa Capital, a fledgling agency brokerage in the rates space and one of the most experienced people I know in London when it comes to the whys, the  hows and the wherefores of the government bond market.
He made a very strong point that, as far as he was concerned, size didn't matter. To him there was only one critical issue of concern and that was the subject of mutualisation of risk. With it, so he reckons, the Eurozone is headed for stability. Without it, it is doomed in as much as it effectively ceases to be a harmonious, homogenous area. The dream of making a United States of Europe in the image of the United States of America is dead in the water and any claim the euro might have had to be like the dollar has just gone up in a puff of smoke.
As recently as Wednesday night, the Dutch parliament had voted against mutualisation and thus, with the Germans, the Finns and the Austrians also averse, unanimity was never going to be achieved. A split vote was not an option and so there had to be a fudge. The question was, how heavily was the fudge going to be tainted with the flavour of sauerkraut? When I heard Draghi begin to explain the split in loss-sharing, I knew all was not right. Ian titled his analysis of the outcome with "Mario Swings a Big Bat, But Misses the Mutual Ball?" Please permit me to share some of his thoughts:
"Call me a cynic, but you're trying to hide the fact that you failed to force through the most important component of the QE program... namely loss sharing, liability sharing, mutualisation, or whatever you want to call it and you end up with at best 20% loss sharing only, of which only 8% is on government bonds. You hide this shortcoming in the fetching headlines that you will be buying up to €60bil/month combined Public & Private securities. And on top of that you make the program longer than some expected taking it up to at least Sept/2016, having started in Mar/2015. That is in theory €1.14trn of securities you will accumulate. Sounds big right? Then the cherry on the Smoke and Mirror Cake is that you tell everyone you will make the program conditional on achievement of your mandate for price stability. Saying that the program will go on as long as needed. Or open ended if you like."
He continues "To illustrate how big the party is in Berlin tonight... Based on what is clearly a big win on the compromise (I'd say outright victory) that Germany and its allies wrung out of Draghi. Look at some rough numbers for new German joint loss sharing exposure by the end of the Program when and if the ECB and National CBs manage to buy the total of €1.14trn by Sept/2016. Based on the Capital Key, Germany is responsible for 18% of that total or €205.2bn and of that only 8% is held by the ECB with loss sharing. So that means that the total non-Bund exposure for the BUBA is only an additional €16.4bn out of the grand total of €1.14trn bought. It'll be lots of beer and sausages all around!!"
"That tiny 8% is symbolic, but not in any way significant enough to prevent, over time, the segregation/tiering/fragmentation of the credits within the Eurozone borrowers. The Haves vs. the Have Nots. I will expect, when the dust settles and purchases begin, that the credit spreads between the strong and the weak will widen. This is not a program that is designed to float all boats equally."
"It is a divisive piece of policy that Draghi, in my mind, has lost a lot of credibility over. He and other members clearly caved in to the demands of the big bully(s) on the block. And for me, despite the big size headlines and open ended-ness of the program, it comes up short of what is needed to maintain the structural integrity of European Monetary Policy and Fiscal Unity."
So, while they were dancing on the floors of the stock exchanges and while all the high fiving was going on that St Mario and his merry men had finally come to the rescue, wrapped in open-ended QE, it could quite well be that the seeds of the final destruction of that strangest and most incongruous of constructs, the European Single Currency, were yesterday sown.
It might, of course, be that the euro softens a little bit, that inflation is imported to the tune of roughly 2%, that exports pick up enough in order to push Eurozone unemployment down from the current 11½% to 5½-6%, that construction and consumption accelerate, that fiscal revenues rise to the level at which deficits are wiped out and surpluses are achieved without legislative intervention or trimming of benefits and that pigs learn to fly. Or it might be that the whole system falters when driving down the road by hitting a whole pile of cans which had been kicked there over time." - source Anthony Peters - "On the ECB and mutualisation of risk":

This is exactly what has happened with the QE plan put forward by our"Generous Gambler" aka Mario Draghi. Back in July 2012 in our conversation "Europe - The Game of the Century" we argued the following:

"The only possible Nash equilibrium for Germany will be to defect"

While only appearing to be making material sacrifices, German Chancellor Angela Merkel has managed to keep Germany's liabilities unchanged, this is again the case with the present QE, as it was the case with the capped ESM and EFSF.

As we indicated in our conversation "Eastern promises" on the 9th of June 2012, we still believe that eventually Germany will defect in the end:

"We think the breakup of the European Union could be triggered by Germany, in similar fashion to the demise of the 15 State-Ruble zone in 1994 which was triggered by Russia, its most powerful member which could lead to a smaller European zone. It has been our thoughts which we previously expressed."

We would like to point out there is no such thing as a credit-less recovery in Europe as discussed in our conversation "In the doldrums":

"If credit growth does not return, economic recovery may prove to be difficult in the absence of sizeable real exchange rate depreciation." - Zsolt Darvas - Bruegel Policy Contribution.

"So for us, unless our  "Generous Gambler" aka Mario Draghi goes for the nuclear option, Quantitative Easing that is, and enters fully currency war to depreciate the value of the Euro, there won't be any such thing as a "credit-less" recovery in Europe and we remind ourselves from last week conversation that in the end Germany could defect and refuse QE, the only option left on the table for our poker player at the ECB:"The crux lies in the movement needed from "implicit" to "explicit" guarantees which would entail a significant increase in Germany's contingent liabilities. The delaying tactics so far played by Germany seems to validate our stance towards the potential defection of Germany at some point validating in effect the Nash equilibrium concept. We do not see it happening. The German Constitution is more than an "explicit guarantee" it is the "hardest explicit guarantee" between Germany and its citizens. It is hard coded. We have a hard time envisaging that this sacred principle could be broken for the sake of Europe."

What do we do sir? 

When the facts haven't changed, we do not change our mind.  In the European QE, there has indeed been no move towards "explicit guarantees" as it would have indeed entailed a significant increase in Germany' s contingent liabilities hence our continued negative stance on the future of the European Union.

On a final note we leave you with Bank of America Merrill Lynch's graph displaying Labor force growth vs US CPI from their Thundering Word note from the 18th of January 2015:

"Technology and demographics (Chart 3) continue to act as secular deflationary forces across the developed world. The end of QE in the US means the Fed is no longer inflating asset values. And investors are increasingly concluding that QE has ended up creating excess supply rather than excess demand. The relentless “lust for yield” continues. In Q1 it is the turn of REITs to be the asset class attracting large speculative inflows in search of Yield & Growth." - source Bank of America Merrill Lynch

"We need to ask whether, in the long term, some individuals with a history of psychosis may do better off medication." - Thomas R. Insel, American scientist

Stay tuned!