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Ultimately, all financial roads lead to Wall Street. The big investment banks and trading firms known as primary dealers all play in one worldwide money pool. When the ECB prints money, it's not just available to Europe, it is also instantly available to Wall Street.
Growing European bank deposits have always strongly correlated with U.S. Treasury note prices. However, that correlation has broken since mid-2016. Instead, European bank deposits have correlated strongly with U.S. stock prices. That suggests that capital flows from Europe have been a key support to the U.S. stock market rally.
European deposits have grown as the ECB has pumped trillions of euros into the banking system. Deposit growth has not kept pace with the growth of the ECB's balance sheet. This also suggests that money has been leaving the continent and heading to Wall Street.
But that could all be about to change…
At the end of October, the ECB announced that it would cut QE to €30 billion a month in January 2018. That's a 50% cut. That's money that will no longer be available to feed the U.S. financial asset bubble.
This comes at the same time as the Fed is gradually ratcheting up its cuts to the size of its balance sheet to $20 billion per month in January, increasing to $50 billion in October. The Treasury will need to issue more supply to redeem the Fed's holdings that it is cutting from its balance sheet.
Finally, the ECB cut will also coincide with the revenue reductions that will result from the Trump tax cuts. This will expand the deficit and require the issuance of even more new Treasury supply.
With the ECB cutting its cash injections into the worldwide money pool by $30 billion per month on top of these other negative factors, this is a recipe for falling prices for both U.S. bonds and stocks as 2018 progresses.
European Banks' Love Affair with U.S. Stocks Is About to End
Total deposits surged in October and November. The annual growth rate is now 3.6%, most of which is due to the March TLTRO (targeted long-term refinancing operations). These operations pay the banks a reward for making loans. The TLTRO resulted in an increase of a whopping €293 billion ($352 billion, or 1.7%) in March.
The banks are no fools. There's very little loan demand in Europe, so the banks engage in round robin lending operations to each other to qualify for the TLTRO bonus.
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Even as the TLTROs are repaid, some of the deposits created when the ECB buys bonds outright stick around. Since the ECB started QE and NIRP at the end of 2014, it has managed to goose deposits in Europe's banks by a total of 5.8%. Without the two TLTRO facilities, the growth rate would be close to zero. QE alone has had very negligible effect on the level of bank deposits. And the TLTROs are smoke and mirrors.
The total increase in deposits since the inception of NIRP/QE is now €967 billion ($1.16 trillion). That is shocking considering that the ECB has pumped €2.5 trillion into the banks over that time. Most of it has disappeared. Depositors have used some of it to buy assets in the United States and elsewhere. Much of the rest has gone toward paying down debt, thereby getting rid of the cost of holding deposits or European sovereign paper with negative yields.
Surging deposits in Europe have in the past been a bullish sign for U.S. markets. The correlation is strongest with Treasuries, as Europeans with cash tend to buy U.S. Treasuries. But some of the deposits created when the ECB prints money are also used to buy stocks.
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Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.