Never underestimate the shock value of the European Central Bank.
It should not be news to anyone who has been paying attention that the central bank isvery likely lining up a new dollop of easing at its final scheduled meeting of the year next week. And yet every fresh sniff of action send the euro, and bond yields, sliding. That happened yet again yesterday, and the effect has not worn off.
“Mario Draghi is regularly under-estimated,” said Kit Juckes at SocGen. “‘Whatever it takes’ means exactly that.” Well, quite.
In very subdued Thanksgiving Day trading, the euro is holding steady just above $1.06, with no bounce back from the drubbing that followed the Reuters report yesterdayfleshing out how the (potential) extra easing will work. One plan under consideration, Reuters wrote, is to create a two-tier deposit rate – a move that could cushion commercial banks from too much damage from a penalty on parked funds.
Once again, analysts and investors are rethinking the ECB’s next step, and upping the ante.
Says BNP Paribas:
Our economists have revised their forecast for the ECB’s 3 December policy meeting and now expect a 20bp deposit rate cut (10bp previously). This is in addition to a €10bn increase in the monthly rate run of asset purchases and a 12m extension of the programme to September 2017.
We expect the euro to remain under pressure as expectations for ECB action continue to build, particularly given that short euro positioning remains light
A few key lines from Bank of Japan boardmember Yutaka Harada help explain why the central bank held fire at its October 30 meeting.
Mr Harada, speaking in Tochigi on Wednesday, was a little more downbeat — one is tempted to say realistic — about the economy, than BoJ chief Haruhiko Kuroda.
He acknowledged as much, saying his outlook on the economy and inflation is “slightly weaker” than the central bank’s. He also cited a number of overseas risks: slowing emerging markets, especially China; an “unexpected shock” from the US lifting interest rates, or Europe’s debt crisis resurfacing.
In the event these events hurt Japan, the BoJ “should implement additional monetary easing without any hesitation,” he said.
But, Mr Harada was less concerned about the forces of domestic support, i.e. consumption and exports. While neither is exactly firing on all cylinders, he has a similar outlook to Mr Kuroda, which emphasises how the tight labour market will create a “virtuous cycle of income to spending.”
And here’s the key: while almost half of economists expected the BoJ to cut its inflation target last month, then respond with renewed stimulus efforts, Mr Harada downplayed the need to hit the BoJ’s 2 per cent inflation target right away:
The Bank of Japan is caught in a dilemma. The central bank has fallen behind in its pursuit of inflation, but speeding up asset purchases could produce the wrong kind of price growth even as wages remain sluggish.
The trend in prices has been one of steady improvement, BOJ Gov. Haruhiko Kuroda stressed to reporters Friday.
He and the rest of the bank’s policy board had just pushed back the target date for reaching its 2% price growth target by six months, but they did not increase monetary easing.
Excluding fresh food and energy, consumer price index growth did quicken to 1.2% year on year in September, up from 1.1% the month before. This marks the fastest pace since Kuroda’s BOJ launched its current quantitative easing program in April 2013.
But with energy prices factored in, inflation remained negative for a second straight month. This reflects a drop in the price of crude oil that will eventually fade into the background. But if inflation stays close to zero after that, consumer expectations of rising prices may remain low.
“We have to keep a careful watch for changes in the trend,” a senior BOJ official said.
The European Central Bank is positioned to expand its €1.1tn asset-purchase programme and cut its deposit rate in December after Mario Draghi announced the bank was “ready to act when needed” should the slowdown in emerging markets threaten the currency area’s economic recovery.
The euro weakened from $1.131 to $1.123 against the dollar after Mario Draghi, the ECB’s president, said policymakers’ measures would need to be “re-examined” in December. Mr Draghi said the central bank stood ready to adjust the “size, composition and duration” of its quantitative easing package. At the moment, the ECB is buying €60bn of mostly government bonds a month which it intends to do so at least until September 2016.
Two-year German government borrowing costs, seen as a benchmark for the rest of the eurozone, sunk to a record low of minus 0.293 per cent on the news.
While the programme appears to have thawed the region’s credit markets, growth remains lacklustre and inflation has fallen back into negative territory. The ECB president said the outlook for inflation was now “less sanguine” and warned of the risks emanating from emerging markets, notably China.
Some members of the 25-strong council had called for action as soon as Thursday, although Mr Draghi cautioned that this was “not a prevailing theme” of the policy deliberations.
The ECB could also renege on an earlier promise to leave interest rates unchanged and cut its deposit rate further into negative territory, a move which is likely to weaken the euro if realised. The ECB president said cuts into negative territory by other central banks, such as the Swiss National Bank and Scandinavian authorities, had led the ECB to reassess where the lower boundary for interest rates lay.
Positive momentum for EM assets looks to extend its moves from last week. EM sentiment is being buoyed by gains in developed markets equity indices, the weaker dollar more broadly, and gains in the commodity space. Regarding the latter, we note that the moves in the MSCI EM index, for example, have closely mirrored the moves in CRB commodity index, even though the benefits to EM countries from moves in commodity prices are far from uniform.
Looking ahead, China trade numbers and Turkish current account data will be watched closely. On the political side, Brazil will remain a focus as markets still try to assess whether the latest cabinet reshuffle by the government will bear fruits. In Turkey, we doubt that the terror attack in Ankara will have a material impact in the upcoming elections on November 1, but it increases the risk of social discontent. Elections in Poland, Argentina, and India (regional) are coming up, but we will discuss these more in depth in separate upcoming reports.
China reports September trade Tuesday, with exports seen at -6% y/y and imports at -16% y/y. CPI and PPI will be reported Wednesday, with the former seen rising 1.8% y/y and the latter seen falling -5.9% y/y. New loan and money supply data should come out this week. New loans are expected at CNY900 bln, while M2 is seen rising 13.1% y/y. Data is likely to be soft, but unlikely to put much of a dent into the recent global equity market optimism.
Singapore reports advance Q3 GDP Wednesday, and growth is expected at 1.3% y/y vs. 1.8% in Q2. The MAS typically meets that same day. Given weakness in the economy and rising deflation risks, we think the MAS will loosen policy with an adjustment to its S$NEER trading band. August retail sales will be reported Thursday, and are expected to rise 1.6% y/y vs. 5.2% in July. Lastly, September trade will be reported Friday, and NODX is expected at -3.1% y/y vs. -8.4% in August.
Normally we look at macroeconomic news to provide the incremental additional information that shapes the expected returns on investments. However, in the week ahead, the macroeconomic data is of less importance than the reaction function of policymakers. What we mean by this how policymakers will respond to the recent data may be a bigger driver of financial assets than the new data.
Recall that the ECB staff cut its growth and inflation forecasts. Is that not a necessary pre-condition for a policy response? Japan recently reported an unexpected decline in industrial output and the BOJ’s core inflation measure (excludes fresh food) slipped back into negative territory for the first time since April 2013. Is this something that monetary policy can address or should fiscal policy? Will the apparent pick-up in wage pressure in the UK over the past few months push the Bank of England toward a more hawkish posture?
The Federal Reserve officials were likely as surprised by the weakness of the September jobs report as were market participants. There was nothing in the ADP estimate or weekly jobless claims that had hinted at the weakness. Did the disappointing jobs data really redeem the Fed was criticized for not raising rates last month? Will the jobs data be understood by the central bank as a sign that the economy is deteriorating, as the cynics have argued, and require additional monetary stimulus in the form of new asset purchases as former Treasury Secretary Summers and others have claimed?
There are three major central banks that meet in the week ahead. They are the Reserve Bank of Australia, the Bank of Japan, and the Bank of England. None is expected to change policy. If there is a surprise, the Reserve Bank of Australia is a most likely candidate. The policy has been on hold since May. The headwinds emanating from China and through a negative terms of trade shock are still feeding through the economy. However, with recent economic data firm, and the Australian dollar chopping around its recent trough, the RBA need not be in a hurry to cut rates now.
Whatever the economic question, central bankers aren’t the answer
European Central Bank governing council member Benoit Coeure to MNI today:
“European needs innovation; the ECB can’t provide this.”
It’s not just a European thing but everyone infatuated with the idea that central bankers can do something for the economy. We’ve already gone deep down the central bank wormhole over the past 7 years into dangerous, experimental policy while politicians are repeatedly let off the hook.
Governments are the only way to stimulate long-term growth and the best way to do it is to educate, stabilize and help innovators innovate.
Japan has failed to make any hard choices for a generation and now it has the national pension fund buying junk bonds and the BOJ thinking about yet-another round of QE. Here’s a better idea, make it easier for women to go to work. Open up industry to competition. Allow some immigration.
European politicians want the ECB to magically make the economy grow and inflation appear when they’ve built up unfathomable bureaucracy driven by hordes of politicians when one lady is calling all the shots anyway.
Our thesis over the last few years has basically been that the global financial system/economic fundamentals are so bad that its good for financial assets given it forces central banks into extraordinary stimulus and for them to continue to buy assets in never before seen volumes. The system failed in 2008/09 and rather than allow a proper creative destruction cleansing, policy makers have been aggressively propping it up ever since. This has surely led to a large level of inefficiency in the system which helps explain weak post crisis growth and thus forces them to do even more thus supporting asset prices if not the global economy.
However since the summer this theory has been severely tested by China’s equity bubble bursting, China’s small ‘shock’ devaluation and the start of a rundown in reserves for the first time in over a decade. We’ve also seen associated commodities and EM woes, endless unsettling speculation about the Fed’s next move and more recently the idiosyncratic corporate scandal around VW and funding concerns around Glencore. The hits keep on coming. Is it now so bad it’s actually bad again?
The most recent leg of the sell-off begun after the Fed held rates steady two weeks ago as the narrative focused on either this reflecting worrying economic concerns or a Fed that is a slave to financial markets and losing credibility. So do we think we’re now entering a period where central banks are increasingly impotent? The answer is that they have been for a while on growth so not much has changed. However they can still buy more assets and continue to keep policy loose. Although we don’t think QE and zero interest rates does much apart from prop up an inefficient financial system it’s all we’ve got until we have a huge policy sea change which probably only happens in the next recession (more later).
The European Central Bank has suspended buying bundles of loans backed by Volkswagen assets as it reviews the financial implications of the scandal engulfing Germany’s biggest carmaker.
The plunge in VW shares buy almost a third in 10 days has prompted the central bank to review whether to bar VW paper from its bond purchase programme.
Such credit reviews are a routine part of the ECB’s efforts to protect taxpayers as it rolls out its scheme to buy asset-backed securities, which began in November last year.
But the fact that VW, one of Europe’s biggest issuers of debt, is under the microscope underlines the severity of the problems faced by the group, and the potential knock-on funding effects of the scandal.
Shareholders raced to offload VW stock last week after US regulators revealed that the company rigged US emissions tests for its diesel cars by using so-called defeat devices. The allegations forced the departure of VW’s chief executive and rocked Europe’s carmaking industry.
Markit is painting a bright picture of business in the eurozone, with the best quarter in four years, despite a dip in September. The figures may be too bright to encourage the European Central Bank from pumping in more easing, the research company said.
Markit says, with the release of its purchasing managers index covering the views of 5,000 companies, that its surveys
pointed to steady growth of the eurozone economy at the end of the third quarter. Moreover, faster growth of new work and backlogs of orders point to continued expansion in coming months.
The surveys track sales, employment, inventories and prices to try and offer a compete picture of the private sector economy.
The first reading of Markit’s services activity index dipped to 54 from 54.4 in August, while the manufacturing index slipped to 52 from 52.3.
France lagged the upturn, but did see growth pick up in September.
Chief economist at Markit Chris Williams said:
The ECB would no doubt like to see more bang for their euros as far as stimulus from their QE programme is concerned, but it’s debatable whether these numbers are weak enough to convince the central bank to take more aggressive action just yet.
France remains a particular concern. The PMI data signal 0.4% growth of the German economy in the third quarter, but a mere 0.1% expansion in France.