Again the euro took a hit touching 1.14 versus the dollar earlier today following: first yesterday’s unprecedented demands by the European Commission on the Italian government to revise their budget for 2019, followed by today’s weak PMI data across European majors – including 1 and 2 point shortfalls from forecasts for German manufacturing and services respectively.
The ECB left its policy rates, QE stance, and its forward guidance on rates unchanged at yesterday’s meeting in line with market observers’ expectations. President Draghi called the Trump-Juncker deal a “good sign” but still noted downside risks to the outlook from trade. He continued to call the outlook for growth as “broadly balanced” and noted some improvement in recent survey data.
For the next 5 days we feature extracts from our macro-economist Bob Gay’s latest piece ‘Policy Blunders and Currencies’
In December 2015, I wrote a commentary entitled “The Illusion of Policy Divergence” which expressed my concerns on the longevity of the so-called ‘reflation trade’ that was in fashion at the time. The consensus of opinion was that US monetary and fiscal policies were poised to diverge from those of the rest of the world because the Federal Reserve had embarked on a pre-programmed exodus from quantitative easing and zero interest rates, while President Trump was promising to undertake a major fiscal stimulus with a massive infrastructure program. That policy mix – tighter monetary conditions and loose fiscal policy – tends to be a classic prescription for currency appreciation, at least as long as it generates a domestic economic cycle that is asynchronous with what is happening elsewhere.
Klass Knot, the Dutch Central Bank President, has said in an interview over the weekend that the European Central Bank (ECB) should make it crystal clear how it will end its current bond buying programme that is due to expire in September this year. ‘The program has done what could realistically be expected of it’ he told a Dutch current affairs programme.
In recent congressional testimony, Chair Janet Yellen expressed dismay that inflation has remained persistently below the Fed’s target of 2% despite years of monetary stimulus and a decline in jobless claims to its lowest level in more than 40 years. This recent shortfall in US inflation seems strikingly ‘abnormal’ relative to that of recent years, especially in the context of a tighter domestic labor market and comes at an awkward time as the Fed has set course for an historic unwinding of its extraordinary policies of the past eight years. Will low inflation derail the Fed’s exit strategy? If not, where are they headed?
Yesterday’s hawkish testimony from Fed Chair Janet Yellen sent the Dow and SP500 to new all-time-highs along with a rally in the dollar and global equity markets and pushed Treasury yields back above 2.5%. Markets seem to have focused on her reference to the recent improving economic data - drawing a consensus that a June (or even the possibility of March) rate rise may be on the table. However Yellen also stressed caution over the uncertain economic picture; notably the risks and ‘considerable uncertainty’ associated with the current administration’s plan to boost growth through further unsustainable fiscal stimulus. In contrast she stressed ‘the importance of improving the pace of longer-run economic growth’.
Yesterday the Bank of England (BoE) found itself unable buy enough long dated gilts as investors continue to cling on to developed government bonds of all varieties. Following the BoE’s decision to cut the UK base rate and expand its quantitative easing programme by £60bn it only managed to receive offers to purchase £1.12bn of gilts with maturities over 15 years versus their target of £1.17bn. At least part of the reason for this shortage of availability is the more illiquid markets over the summ er – indeed the ECB overbought in earlier months in expectation of such illiquidity but the recent post Brexit expansion of QE obviously had no such option. This prevailing shortage, versus demand, of government bonds looks likely to remain a prolonged dilemma for central banks and investors alike.
Greed and fear drives financial markets and investor risk appetite has returned after a bout of extreme pessimism at the start of February. The VIX index of volatility remains in the low part of the range and the S&P is trading just off its all-time high reached earlier in April despite US earnings forecast to fall (-6.1% yoy according to Thomson Reuters). Increased risk appetite is also prevalent in fixed income markets with the high yield and energy sector having rebounded but also seen by strong investor uptake in the new issue market.
Yet again the IMF has downgraded their global growth estimates to 3.2 percent for 2016 and 3.5 percent for 2017. Their policy prescription is more proactive use of fiscal policy and structural reform in conjunction with already supportive monetary policy. Indeed a criticism of current policy is its over-reliance on central banks and that the prolonged use of QE and negative rates bring unintended consequences. Olivier Blanchard, now at the Peterson Institute in Washington, but formerly the Chief Economist for the IMF, said he is wary on the use of negative rates saying “I don’t like it, I think it interferes with the business of banks in ways that are very complex” instead “I much prefer what we now call regular QE.”
An interesting report yesterday from Bank of America Corp looks into who has been the big beneficiary from the easing of interest rates over the last several years and the Quantitative Easing (QE) put in place by central banks. The report says that there have been 606 interest rate cuts globally since the collapse of Lehman Brothers Holdings Inc. and over USD 12.4tn of asset purchases since the rescue of Bear Stearns Cos.
What a difference a day makes. Chinese stocks have reversed the recent sell-off, which had sent shockwaves across global markets earlier in the week, rebounding over 5% today. In fact, some stock actually had to be suspended having rallied 10%, the maximum allowable daily movement. Markets remain nervous but sentiment has been supported by New York Fed President Bill Dudley’s dovish comment yesterday that a September rate hike “now seems less compelling”. Futures markets have been quick to react; the probability of a rate rise in September has shifted markedly lower from roughly 55% earlier this month to 24% today.