What, exactly, do markets need from the ECB?
- Commodity prices, currencies on the mend in recent weeks
- Signs suggest inflation (and not its opposite) could become a problem this year
- BoE Brexit plans include liquidity-boosting cash injections
By Neil Staines
“If things are going untowardly one month, they are sure to mend the next” — Jane Austen
A month ago this week, global financial markets appeared to be in meltdown. Equities were making new cycle lows, capital flight out of China and into bonds accelerated, gold broke out of its multi year downtrend at the expense of industrial commodities (led by oil).
Market participants and commentators laid the blame on the economic slowdown in China and extrapolated expectations of future yuan declines, the collapse in the oil price (and the related fragilities in energy and related credit), and the troubling decline in inflation expectations. All of which led to renewed fear of a global deceleration, if not recession, and further global forays into untested monetary stimuli.
A month on and relative price levels in a number of asset classes have changed, perhaps remarkably. US equities have rallied over 11%, oil has rallied over 45%, and some industrial metals have risen even further.
We are clear in our view that the progression of ever more accommodative (and unconventional) monetary policy as well as the increased utilisation of "forward guidance" has led to a greater focus on the short-term data fluctuations and has thus exacerbated broad financial market volatility.
After the substantial gyrations of financial markets over recent weeks, this week will see the market's attention turn back towards central bankers.
“I will stir the smooth sands of monotony” — Peter O’ Toole
The seemingly relentless oil price decline over the last couple of years has clearly been a key factor in driving global headline inflation rates down, and ultimately global policy rates lower. More worryingly from a central banker’s perspective, this trend has more recently unanchored inflation expectations (at least as derived from world bond markets).
However, at the start of this year, we warned that it could in fact be inflation that becomes the biggest worry for global markets in 2016, not deflation. Recent US data (CPI and PCE), in fact, show signs of inflation accelerating.
While markets prepare for the European Central Bank to ease policy to fight the downside threat to inflation this week, Federal Reserve vice-chair Stanley Fischer warned last night that the US is experiencing the “first stirrings” of rising inflation.
Despite the disappointing wage inflation print from the US February unemployment report (likely a function of employment growth being concentrated in low-wage jobs), it is becoming clearer that inflation – as distinct from inflation expectations – is rising in the US, where core CPI is running at 2.2% and core PCE at 1.7%.
With global commodity prices at historic lows in many instances, a small pick-up in demand, or even expected demand (as we saw in the dramatic 19% rally in iron ore yesterday) could have substantial implications for US and global inflation. In our view, the risk of higher inflation in Q2 and beyond is growing.
“The opposite of bravery is not cowardice, but conformity” — Robert Anthony
Meanwhile in the Eurozone, the ECB is looking in the opposite direction. Following the markets’ sharp disappointment at the December meeting, confidence if not expectations are more subdued for Thursday. In our view, this suggests that the downside risk to the EUR, if the ECB delivers, is increased as markets are not pre-positioned to the same extent.
What constitutes the ECB "delivering", however, is another story. From our perspective, any further foray into negative territory is a clear negative for the currency and should also further promote the correlation adjustment between "risk" and the EUR.
We feel that a more negative rate is equally negative for equities (beyond the initial response) and the currency, with the yield curves already negative out to almost 10 years.
This week also sees the central banks of Canada and New Zealand in action. While we would concur with market expectations that there is little chance of further action from the Bank of Canada, we view the chances of a cut from its New Zealand counterpart as being higher than the market is currently pricing in given the sharply weaker consumer and business confidence surveys, a slowdown in the country’s housing hotspots, and a stubbornly high currency.
The BoE also made headlines yesterday with the announcement that it will provide unlimited additional liquidity in the weeks around the EU referendum through long term repo operations, linked to the bank's policy rate.
The fact that just last month Mark Carney said that it serves nobody’s interests to talk in detail about referendum contingency plans perhaps highlights the growing sensitivity to the Brexit debate and ramifications.
With little on the data calendar today, we would not expect too much deviation ahead of the risk events later in the week. However, following the sharply weaker Chinese trade data overnight we would expect the recent equity, industrial commodity and risk-positive currency rally to encounter increased resistance (if not outright decline) over the coming sessions.
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group