An exciting start to 2015 in Europe

January is off to a brisk start for traders and central bankers in Europe. I see no quick turnaround to Europe’s economic malaise.

The ECB is widely expected to announce a well telegraphed QE announcement this week. The hints going around are slightly higher than I expected, at around 600B Euros. If the ECB is being quite clever they may take a page from public companies and be leaking slightly lower numbers so as to “beat expectations.”

My expectation is that QE alone will not be successful in moving Eurozone inflation back toward its upper bound of near 2%, though any bounce in oil would help, or in stimulating noticeably faster growth in the Eurozone. My argument is the three toos: 2015 is too late because rates are already too low and in any event EUR 600B is too little. I am assuming that QE works through the portfolio channel, and that by taking government bonds out of circulation, cash will have to be deployed in more risky, and hopefully investment stimulating instruments. But rates are already so low in most of Europe that it is hard to see what a slight decrease in rates will do. For example, the Spanish 10 year bond is yielding 1.5% according to Bloomberg, will 1.4% or 1.3% make much of a difference? Though it is possible that after all the hints from Frankfurt, at this point the market is pricing in QE and if they did not do it yields would increase significantly.

What might make a difference would be a large coordinated expansion from countries with fiscal room but this is unlikely to transpire.

What will happen in Greece is different question. An election may usher in a new government which wants debt write-offs. I think the consensus of economists is that Greece will indeed need debt write-offs, though they may need to be hidden in maturity extensions and interest payment deferrals. As the bulk of Greek debt is held by the official sector, this is possible if well enough disguised. I do not see Greece leaving the Euro. They will not leave by choice and being expelled would put tremendous pressure on at least Portugal and perhaps even Italy. If Cyprus can stay in the monetary union why not Greece?

Finally, the Swiss National Bank lifted a three year old cap on the exchange rate of Swiss Francs to Euros. As recently as last month this looked like a rock solid policy and the market was caught completely off guard. One lesson we can draw from this is: there is no such thing as an absolute promise from a central bank. Policies are fixed for a particular purpose and in a particular political context. In this case the SNB has not even convincingly explained why they suddenly ripped off the Band-Aid. A minor point is that the SNB moved deposit rates down to -0.75. If they manage to make this stick, markets paying up for safety in the form of negative interest rates may become more widespread.

Overall, direct implications on the US are negative, though modest. We have seen further dollar strength which will tend to slightly reduce exports and hence growth. The more direct effect is the continued high price in risk-free assets, by which I mean US government bonds. I mentioned a few weeks ago, NY Fed President Bill Dudley has said that when the Fed does raise rates it is going to want to see a genuine tightening in fiscal conditions. US 10 year bonds at 1.85% is unlikely to qualify implying more than just token rate rises when the moment comes.