I told you on Wednesday that, thanks to my experience in the real estate world, I have my eye on an impending housing bubble that you are almost certainly not watching right now.
But you should be… because it has very real implications for your money.
Thanks to central bank policies, housing bubbles are happening again today, not just in the US, but in Europe too. Europe matters to us, a lot. It matters because a steady flow of buy orders from European dealers, banks and investors is required to keep US stocks and bonds inflated. US markets would collapse without European buying.
That’s why I take a close look at the ECB’s monthly data on the European banking system. And what we see today in the just released data from January has scary implications.
This Immensely Fragile Situation Comes At The Worst Possible Time…
Since 2013 the population of the European Union has grown by about 2%. That’s a growth rate of roughly 0.4% per year. Over that span, consumer prices in Europe have inflated by a total of 3.4%, an average of less than 0.7% per year. Meanwhile, European home prices have risen by 16%. When house prices inflate 8 times faster than population growth and nearly 5 times faster than consumer price inflation, in my book that’s a bubble.
And we know what drives it – central bank policy that keeps mortgage rates at abnormally low levels, along with a policy that penalizes depositors for holding deposits – negative interest rates. These policies have succeeded in stimulating housing bubbles, but have failed to trigger broad economic growth.
The ECB has jumped through hoops promulgating the twin insanities of QE and negative interest rates. QE is printed money used to buy European bonds, thereby pushing down European long term interest rates, including mortgage rates. Buyers get abnormal subsidies from super low interest rates, and sellers get inflated prices.
But then the ECB uses negative interest rates to penalize the holding of deposits. Negative interest rates hit big institutions who hold massive deposits. Thus they have an incentive to extinguish deposits by using them to pay off debt. They get rid of loans faster than they take them out.
The result is that the ECB’s objective of stimulating credit growth and thereby economic growth can never be met, because banks and other large entities pay down loans to get rid of the cost of holding deposits. There’s just not enough profit opportunity in the real economy for them to take out more loans on balance. Consequently, business credit growth in Europe has been stagnant, absolutely dead, since the ECB instituted the negative interest rate policy (NIRP) and QE in September 2014.
Meanwhile household debt in Europe has soared since the start of QENIRP.
Household debt to banks had been growing at an accelerating rate with the rise becoming parabolic in 2017. It downticked in January, but only slightly. Household loans are now growing at a 3.4% annual rate. That’s down a tick from 3.5% in December but still up from 2.0% a year ago. The fact that consumers are adding to debt while the business is getting rid of it, maybe isn’t a good sign.
In fact, it could be a reflection of that housing bubble. Mortgage lending rose €170 billion (4.2%) in the past 12 months, despite the first slight downtick in a year in January. That annual increase accounted for 90% of the rise in consumer loans. The increase in mortgages was also 68% higher than the annual increase in January 2017. Mortgage borrowing has been accelerating along with European home prices in the last year.
While households are increasing their mortgage debt, their revolving credit is in a downtrend. It is now down 6.4% year to year and down 17.4% since NIRP started in September 2014. Other than causing a mortgage bubble, ECB policies have had no positive impact on household borrowing.
The mortgage bubble has once again created a situation of immense fragility at the worst possible time. Housing prices are inflated and borrowers are stretched.
Now the ECB is cutting back QE. In January it reduced its purchase rate from €60 billion per month to €30 billion.
But issuers, particularly European governments, not to mention the US government, certainly aren’t cutting back issuance. They’re adding to the supply of securities that dealers, banks, and investors must absorb. And European banks are big buyers not only of their local sovereign debt, they are also big buyers of US Treasuries. They now have less money available to absorb the flow of new supply.
The supply of sovereign debt is ballooning and the money to purchase it is shrinking. Not only is the ECB buying less, but the Fed is actually pulling money out of the world financial system and markets. It has set a schedule of draining funds from the system that will increase from $20 billon per month now to $50 billion per month in October.
These forces are set in stone by central bankers determined to stick with them until, in Janet Yellen’s words, “a material adverse event.” Nobody knows what that is, but my guess is that it won’t just be a 20% decline in stock prices. I think that it will take a real financial crisis to get them to reverse course.
Meanwhile the ECB keeps floating the BS that the European recovery is strong. It’s cover for the eventually ending their QE program, possibly this fall, based on trial balloons floated by ECB proxies in the European pundit class.
In any event, the first step in course reversal won’t be to print money to buy bonds. It will be to lower nominal interest rates, which will be a “really useless and futile gesture” (apologies to Animal House) for stopping asset deflation. Money printing caused the inflation of the asset bubble, and now stopping money printing will cause its deflation.
Given these forces, such a crisis is inevitable. Only the timing is at issue.
And we have a very good idea about that…
Here’s When This Bubble Is Poised to Burst (And Soak Your Portfolio)
As ECB policy and the European housing bubble promote ever greater financial fragility, another disaster looms as a direct result of ECB policy.
The ECB has been promoting a program called the TLTRO that started in 2016. TLTRO means Targeted Long Term Lending Operations. The essence of the program is that the ECB will pay an interest bonus to banks who take these loans from the ECB and then make business loans above a certain benchmark.
This is free money for the banks. The ECB is telling the banks we’ll pay you to take this money if you lend it out. The problem is, as illustrated above, is that there is NO business loan demand.
But as we all know, bankers are clever little scoundrels. They figured out that they can earn that bonus by simply lending the money to each other. So in 2016 and 2017 they took down about half a trillion in TLTRO money, and simply lent it back and forth to each other. I believe that the January spike is another instance of that. There’s no other explanation for it.
So interbank lending exploded higher to a new high in January. It broke out above the 2008 peak. Need I remind you what happened in 2008?
The annual growth rate of interbank loans is now a scalding 15.6%. Without these interbank games, total loan growth in the European banking system would have been negative over the past year. Interbank loans rose by–excuse me while I rub my eyes in disbelief — €921 billion in the 12 months ended January. Other types of loans barely grew at all or declined.
In March, European banks will be permitted to start paying off their TLTRO borrowings. Let’s listen for a giant sucking sound as banks rush to do that. They will use deposits created when they took the funds to repay the loans. This money, aka “liquidity,” will thereby disappear.
When that money was created, Europe’s banks used some of it to purchase US Treasuries. As deposits grew US Treasury prices rose, causing yields to fall.
Some of that liquidity flowing into the US was then directed toward purchasing stocks.
European banks will almost certainly liquidate those positions in US Treasuries to pay down the TLTROs.
That’s what they did when they were able to start paying down the ECB’s original LTRO programs in 2012 and 2013. European banks had used the LTROs issued in 2011 to buy Treasuries, driving US yields to their lows in in July 2012. As soon as the banks were permitted to start paying down those loans, they did. To do so, they sold their US Treasury holdings.
That selling helped drive the yield on the 10 year Treasury from 1.5% to 3% from mid 2012 through the end of 2013. I have felt, and I believe that we’ll soon know for certain, that that was the end of the secular bull market in bonds.
Now, as the European banks get ready to pay off their TLTRO loans, the 10 year US Treasury yield stands at roughly 2.85%. We’re likely to see that yield move much higher as European banks sell their US Treasury holding to pay off loans from the ECB – loans that they don’t want and don’t need.
Keep in mind that these sales will come in an environment of very heavy new supply being issued by the US Treasury. It will not be pretty.
That giant sucking sound you’ll hear will be a result of three forces. The European banks will be liquidating Treasuries and extinguishing money. At the same time as the US Treasury and other governments will be sucking up all available liquidity from a pool that is simultaneously being drained by the Fed. And chances are that the Europeans won’t be the only ones selling.
As bond prices go down that drain and yields soar, US stock prices will be pulled down in the vortex. The process of money destruction will be self reinforcing, causing liquidation of all inflated assets. The liquidation of stocks and bonds to pay off margin debt will in turn destroy money.
At some point the central banks will be forced to print a lot of money in an attempt to reverse that vicious cycle. But that point is a long way off. Before the central banks respond, there must first be significant pain, that “material adverse event” that Yellen talked about.
I therefore continue to see all rallies in the US stock market as opportunities to sell and raise cash toward the goal of reaching 60-70% cash (more or less depending on your circumstances) if you haven’t done so already. I’d modify the old adage just a bit to “Sell by May and go away.” If you have cash, you’ll be able to take advantage of buying opportunities down the road.