A funding winter is coming
Hopes of a soft landing are optimistic. The hard one has just been delayed
Europe's bond issuers may be well advanced with funding this year, but that does not change the inexorable logic that funding conditions are going to get a lot more difficult, as a cabal of factors is conspiring to drain liquidity from financial markets.
The Belgian government’s recent €22bn retail-targeted bond issue concentrated minds. A huge funding coup is normally cause for celebration. But it was so large that it sucked out a significant share of all retail deposits in Belgium. That spells danger for banks, and for capital markets in general.
Italy and Portugal have already made strides with retail bond issues and other governments might follow suit.
So far, many of Europe’s banks have been so complacent about being able to fund with deposits that they have failed to pass on interest rate rises to their saving customers. The Belgian deal showed they can be tripped up.
Suddenly, Europe has the makings of a deposit war, in which governments and banks fight over retail funding. Governments will relish whittling down what many see as banks’ excessive profits.
Another pulse of funding urgency comes from the European Central Bank, said to be countenancing a fourfold rise in its Minimum Reserve Requirement from 1% of banks' deposits and short term funding to 4%.
This would savage Liquidity Coverage Ratios and profit margins. It could also drive funding away from deposits and towards bond issuance.
Added to this incendiary mix is the prospect that the ECB eventually falls into line with the US Federal Reserve and the Bank of England by actively selling some of the €5tr of assets it holds as a result of quantitative easing.
The ECB’s decision will be based on its view on inflation two years from now. With oil heading up to $100 a barrel and wages powering ahead, the inflation target will be hard to reach.
Investors buying assets from the ECB would necessarily deplete bank deposits. And with bond spreads likely to widen, banks’ net interest margins would be squeezed yet again.
And since most government bonds would be soaked up by domestic buyers, the bank-sovereign doom loop that was given so much of the blame for the last eurozone financial crisis would be back in play.
Or, for those who prefer their peril nice and simple: this week the German five year government bond yield rose to levels last seen in 2008.
The writing is on the wall for all who care to read it.