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The Eurozone's now in one of those 'technical' recessions. The ECB will keep hiking a bit longer, but what's 'next'... Can Europe change?

There's a lot of navel-gazing going on right now. Aside from the AI Supercycle that will transform life as we know it, we're regurgitating 'knowns', the old news, all very boring... ๐Ÿ‘‡

Just as we're getting comfy (and complacent?) with all of these risks, the liquidity withdrawal memes are ready to kick in, and not just in the US.

Now, this is never as simple or mechanical as portrayed. The meme however, is simple.

  • Liquidity down, risk markets down
  • Liquidity up, risk markets up

Easy. As long as we're clear what liquidity is in each context...

For market speculation purposes, we can think of it like, excess money that can't find a home. If there's 'excess money' out there, then it should end up in risky stuff like stocks eventually, or so the theory goes.

The opposite is also supposed to be true. If we clear 'excess money' from the system, then people will need to sell stocks in exchange for 'money', because the spare money pile has disappeared.

Obviously it's way more complicated than that, but also sort of... not.

When there's a 'liquidity withdrawal' or a sudden increase in assets competing for capital, it raises the probability of financial 'accidents', and those usually lead to risk aversion....

There's a couple of those sort of processes happening right now. First up the TGA refill. After the debt ceiling was raised, the US Treasury account was pretty low. Now they need to refill it.

It might matter to wider markets, it might not. Demand for treasury bills is healthy so far...

But there's always the risk that too much is stuffed down the markets throat in coming months, ST yields rise and banks are hit by deposit flight once again. A risk to monitor.

Far less widely discussed is the payback of the ECB's TLTRO's (Targeted Longer Term Refinancing Operations). It's basically a tool to encourage banks to lend (or not, as is the case now). From the horse's mouth ๐Ÿ‘‡

The more loans participating banks issue to non-financial corporations and households (except loans to households for house purchases), the more attractive the interest rate on their TLTRO III borrowings becomes.

As monetary policy is tightening and loan demand shrinks, banks are repaying these facilities ๐Ÿ‘‡

Goldman: Euro area banks have repaid half of TLTRO funding, an additional โ‚ฌ480bn is due in June 2023, and 90% will be repaid by end-1Q24.

"The easy phase is behind us..."

Will TLTRO repayments lead to tensions in the banking system?

Goldman: We do not think so. Banks can seek โ€“ albeit more costly โ€“ market funding, rely on conventional ECB facilities, or contain loan growth.

Hmmmmm. Less than ideal, although loan growth has already been declining for a while...

All of which is unsurprising and expected. Still, the interplay between tighter monetary policy & higher risk of 'accidents' or simply wider spreads is ever-present while the central bank winds the excesses in.

European markets have been relatively drama free for months. That seems unlikely to last, especially as the ECB looks set to hike once or twice more, and because Europe's Europe...


Usually, I'd say there isn't one. It's an absurd basket case that will always be sub-optimal, mired in bureaucracy, idealism and the impossibility of merging very distinct economies into one economic bloc and currency.

I still say those things. But Davide Oneglia of TS Lombard took on the near-impossible task of making a bull case for Europe...

It's clear to everyone that Germany's old model is especially broken. We covered this here ๐Ÿ‘‡

Germanyโ€™s In Deep ScheiรŸe
itโ€™s hard to see how Germany gets through this without some serious long-term scars. A short recession would be an amazing outcome that only the most optimistic could entertain.

No Russian gas, and China's now leapfrogged both Germany and Japan to become the number one vehicle exporter.

Oneglia makes the case that this could actually be a good thing, both for eurozone assets.... ๐Ÿ‘‡

Meanwhile, the mere prospect of a rebalancing of the macro policy mix and its impact on growth drivers (from excessive reliance on exports to more robust domestic demand) over the next cycle are strong pointers to higher EA asset weights in long-term asset allocation globally.

And the economy too...

In other words, donโ€™t fear the demise of the old, dysfunctional EA growth model. A rebalancing from foreign-demand dependency to stronger domestic-growth drivers with the potential for a productivity revival is very good news indeed for the EA economy and asset prices.

Even with so much focus on China needing to rebalance their economy away from exports & towards domestic demand, they just don't seem ready to take that plunge.

While Europe, and especially Germany, seem to have little choice...

And, it's worth posing the question... If not now, when?

DO: The bottom line and what this all means for EA assets. The threat posed to the old EA export-led growth model by deglobalization, higher input costs and greater competition from China and the US is both real and well understood.
The EA is at a difficult crossroads. However, the upside of long-term structural changes in the fiscal-monetary policy mix is still overlooked and poorly reflected in asset prices โ€“ if at all. This is because such positive changes often take time for their effect on the economy to show and are difficult to estimate quantitatively.
Productivity gains, especially those brought about by new technologies, are a classic example. The post-GFC policy mix and macro environment in the EA โ€“ which was characterized by negative interest rates, depressed public and private investment, limited and unevenly distributed productivity gains and extreme dependency on external demand โ€“ is likely to prove an anomaly in historical terms.

I'm not as optimistic on the bureaucracy-busting as Davide, and there are plenty of monetary risks to navigate before anything meaningful happens. The EZ economy is definitely approaching that crossroads. Can they finally deliver?

Weโ€™re Never Going Back
ZIRP broโ€™s look away now - weโ€™re never going back, you had your chance... Even if thereโ€™s a recession, stupidly low rates will be transitory