Busy Week Ahead, ECB Meeting The Stand-Out
Hollande, Draghi agree on threat of deflation: official
French President Francois Hollande and European Central Bank chief Mario Draghi agreed on Monday that deflation and weak growth were threatening the European Union's economy, an official in the president's office said.
Draghi called last week for greater emphasis on fiscal stimulus over austerity - comments that irritated German leaders but were welcomed in France because they hinted at a shift away from a current emphasis on budgetary austerity.
"I think the diagnosis is a shared one," an advisor to Hollande told reporters after an hour-long meeting between the Socialist president and Draghi at the Elysee presidential palace.
The two men shared the view that weak growth and a threat of deflation in the European Union were problems that needed to be addressed, the advisor added.
"We need to work together on demand in Europe," he said.
France has been singled out as a laggard in an otherwise tepid European recovery due to its weak growth rate, record-high unemployment rate and repeated delays in bringing its public deficit below EU targets.
Hollande told Draghi that France - which has already been granted two reprieves by the European Commission on its deficit-reduction targets - would respect commitments to keep enacting structural reforms and bringing down the deficit.
"There are rules to follow, and France will respect them," the advisor said. "This will to raise the growth potential with structural reforms is enormously appreciated."
Will The ECB Crush The Euro?
Will the ECB Crush the Euro?
Thursday’s European Central Bank meeting is the most important event risk this week. The ECB is one of the very few central banks at the cusp of easing monetary policy and based upon the recent decline in EUR/USD and the CFTC’s report on IMM positioning, the market is positioned for a big announcement. Over the past 2 months, EUR/USD lost more than 4% of its value or approximately 600 pips and going into Thursday’s meeting, euro short positions are at a 2-year high. So the ECB really needs to deliver, otherwise is risks triggering a massive short squeeze in the currency. At the Jackson Hole meeting last month, Mario Draghi’s concerns about lower inflation expectations led economists and investors to believe that the central bank will announce additional easing this month and these expectations were reinforced by back to back weakness in Eurozone data. The following table shows how widespread the deterioration in the Eurozone economy has been since the last monetary policy meeting. Everything from inflation to retail sales and economic activity weakened, hardening the case for additional easing.
However Draghi faces a tough choice because stimulus is already in the pipeline in the form of the TLTRO programs due in September and December. The euro also weakened quite a bit, providing support for inflation and growth. Ideally he would prefer to see how the market responds to the new 4-year loans due later this month before increasing stimulus. But unfortunately, the economy and the market may not be willing to wait. Given the trend of recent data, it is not a question of 'if' but of 'when' further easing is needed. Sending a strong message on Thursday could help solidify the foundation for recovery by ensuring that rates remain low and the euro weak. Since the bar is set very high for the ECB announcement, if they want to drive EUR/USD to 1.30, the ECB will need to over-deliver.
One-Two Punch with ABS Purchases and Rate Cut – The strongest message that the ECB could send to the market would be a one-two punch of Asset Backed Securities purchases and a 10bp rate cut. While the central bank is not fully prepared to buy ABS, it could preannounce its plans and say that details will follow. A 10bp rate cut would also be an aggressive move but most likely the ECB would prefer to save this option for a future time because with rates already at zero, the impact would be more psychological. Also, Draghi previously indicated that rates have reached the lower bound, so lowering them again would be inconsistent with his previous views. Any one of these options without the other should still be enough to drive EUR/USD below 1.31, but if the ECB fails to announce any new measures, a massive short squeeze could send the euro back to 1.33. At this time, Quantitative Easing is not legally or practically possible but Draghi will certainly leave this option open. The staff forecasts will be updated this month and we expect the central bank to lower their inflation and growth forecasts.
ECB preview: What could Draghi do?
Ever since Mario Draghi hinted heavily at Jackson Hole that he’s ready to bring out the big bazooka, all the chatter’s been about whether he’ll pull the trigger on full-blown quantitative easing this month. On Thursday, we’ll finally find out.
It’s been only three months since the ECB took its deposit rate into negative territory and launched an aggressive liquidity package, but already more easing could be on the way.
With euro-zone inflation now at an almost five-year low, the ECB is struggling to fight off fears over deflation. Eyes are now on Draghi, to see whether he’ll fulfill his hints of full-on QE.
So, will it come at the bank’s monthly meeting on Thursday? Most economists say no. It’s simply too early to start buying government bonds, they say — especially since the ECB hasn’t yet seen any impact from the targeted long-term refinancing operation (TLTRO) it announced in June.
However, the bank does have other easing options at hand. Some economists expect it to lay out plans for a “private QE” program, under which it buys asset-backed securities (ABS) rather than sovereign bonds. Last week, the ECB said it has hired money manager BlackRock to help design its ABS program.
Others, meanwhile, believe the ECB will cut all key interest rates by 10 basis points, which would take the deposit rate down to a negative 0.2% and the lending rate to 0.05%.
The ECB rate decision is due on Thursday at 12:45 p.m. London time, or 7:45 a.m. Eastern Time, followed by Draghi’s news conference at 1:30 p.m.
Draghi Sees Almost $1 Trillion Stimulus With No QE Fight
Mario Draghi signaled at least 700 billion euros ($906 billion) of fresh aid for his moribund economy and left a fight with Germany over sovereign-bond purchases for another day.
Pledging to “significantly steer” the European Central Bank’s balance sheet back toward the 2.7 trillion euros of early 2012 from 2 trillion euros now, the ECB president today announced a final round of interest-rate cuts and a plan to buy privately owned securities. His mission: to revive inflation in the 18-nation euro area.
Fully-fledged quantitative easing as deployed in the U.S. and Japan wasn’t enacted amid a split on the 24-member Governing Council, with Bundesbank President Jens Weidmann opposing the new stimulus and others seeking more. The latest round of measures pushed the euro below $1.30 for the first time since July 2013 and sent European bond yields negative.
The steps “probably reflect that President Draghi does not have unanimity, or a large enough majority for quantitative easing,” said Andrew Bosomworth, a Munich-based portfolio manager at Pacific Investment Management Co. and a former ECB economist. “The ECB is ready to do more if more is needed.”
Market Movers Episode #14: ECB drama rundown, oil prices and analysis paralysis
Volatility is back. The foreign markets are in turmoil, after European Central Bank President Mario Draghi unleashed a triple-bore stimulus package yesterday morning, surprising participants who had not expected action until later in the year.
The institution lowered its benchmark lending rate from 0.15% to a new low of 0.05%, while pushing the overnight deposit rate further below the zero bound to a negative 0.2%, effectively increasing the cost that regional lenders must pay for keeping funds dormant. Draghi also articulated plans to begin purchasing asset-backed securities and covered bonds in October, eventually increasing the bank’s balance sheet from the current 2 trillion euro level toward 2.7 trillion euro in total.
The announcement smashed the euro through the critical 1.30 mark against the US dollar – a level that it had held since August last year. The 1.6% move was the worst in three years, and added to an eight-week string of losses. The impact shook many participants out of the summertime bliss, and then cascaded out into other markets where we continue to see adjustments occurring this morning.
The dollar is sharply stronger, after a series of positive data releases served to illustrate the contrast with the euro block. With the greenback on the rise, the numeraire effect took a toll on metal and energy prices, dulling gold’s glister and pulling front month crude prices back below $95 a barrel. Supported by a growing US economy and eroded by weakened commodity prices, the Canadian dollar is holding ground in the middle of its recent trading range.
While the euro is extremely unlikely to outperform the dollar in the longer run, we suspect that the market reaction may have been overblown. Draghi managed to startle many observers, but stopped short of the full-blown quantitative easing programme that most economists and politicians have been calling for. It appears that he has run into solid opposition in the central bank’s governing council, meaning that anything more substantive will be pushed well into next year. If so, short yields could rebound and the euro could see a minor snapback in the days to come.
That being said, the euro has now become a full-fledged funding currency for the carry trade, providing traders with cheap fuel to invest in other areas of the world. If yesterday’s announcement spurs another surge in flows to the emerging markets, the consequences could be downright scary.
Either way, it is clear that the predictability which governed markets through the summer has now disappeared. As you navigate the markets this fall, remember that a calm sea never made a skilled mariner. And have a great weekend!
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The week ahead is packed with events and data. The monthly cycle of purchasing managers surveys and the US jobs report are featured. There are also central bank meetings in six, high-income countries and three emerging markets. Given the recent geopolitical developments, in Ukraine as well as with ISIS, the week's NATO meeting will have extra significance.
At the end of the day, there will be little to learn from the PMI data and most of the central bank meetings. Yes, there may be some headline risks, but our information set will not change very much. The euro area flash report steals most of the thunder from the final report. Arguably, more important for the outlook will be German industrial orders and production reports. Modest improvement is expected. The German economy is not really contracting, though it did in Q2.
German exports to Russia are no more than 1% of GDP. Assume that the sanctions cut German exports to Russia by three-quarters. Now put that in the context of last year's growth (0.4%) and this year's projected growth of the German economy (~1.7%). This is not to argue, like many have done, that Germany has no interest in a rigorous sanction regime. Such arguments seem to repeat the error of those who thought the euro zone was going to break up over Greece or Cyprus. So many investors seem to exaggerate economic influences and dismiss political motivations.
We have argued the advent of the EMU and the euro is first and foremost an economic solution to a political problem, the reunification of Germany. Europe itself is more a political construct than a geological one. Political interests overrode economic interests, and that is why the EMU survived. Similarly, the political elite are not Philistines. They can and are putting larger political interests ahead of narrow economic interests. Yes, there are compromises, but an economic determinist explanation and forecast does not do the situation justice.
The PMI data is likely to confirm that the UK economy has lost some economic momentum that was recorded earlier this year. It continues to operate at a high level, but the moderation seen in July likely extended into August.
The US employment data will also most likely confirm what we already know, and if it does not it will likely be shrugged off as a fluke. There is no reason not to look for the 200+ monthly increases in non-farm payrolls to extend the streak to seven consecutive months. Nearly all the inputs that have been reported, which economists use to shape their forecasts, have improved.
Fed officials are looking at the general trend and here is what they see. The acceleration of improvement can be seen in the averages. The more recent averages are above the long-term term averages. The three-month average is 245k. The six-month average is at 244k. The 12-month average is at 214k, and the 24-month average stands at 203k.
The other metrics of the labor market are less volatile, but the forward guidance has raised their significance over the unemployment rate, which is likely to have ticked down to 6.0%-6.1% from 6.2% in July. Average weekly earnings may have ticked up, but the underlying trend remains flat. A small increase would lift the year-over-year rate to 2.1%. The three- and six-month averages are at 2.0%, and the 12-month is at 2.1%. The 24-month average is 2.0%.
Nor will Chinese PMI data likely change investors' views of the world's second largest economy. The economic data shows an economy that continues to expand 7.0%-7.5%, while being in some kind of economic and political transition, though the destination is not immediately obvious. The PMI data will not shed much light on the immediate economic challenges emanating from the circulation of capital as well as the real estate market.
The softer Chinese demand for iron ore is thought to be the key factor driving down prices. The Australian dollar has been resilient, largely in a broad trading range. This underscores our understanding that the ultimate driving force of currencies from open high-income economies is the market for capital, more so than the market for goods. Australia's AAA rating and high yield appeals to both private and public asset managers.
Most of the central bank meetings will not amount to much either. The central banks of Brazil, Mexico and Poland are expected to leave rates unchanged at 11%, 3% and 2.5% respectively. Among the major central, banks, the BOE is not expected to say anything at the conclusion of the MPC meeting. The Bank of Canada meeting will also likely be a non-event. The Reserve Bank of Australia has indicated a stable rate, and there is little reason to expect a change.
The Bank of Japan is surely disappointed with the recent economic readings that showed a pullback in household consumption deepened in July and the half-hearted gain in industrial output. However, Governor Kuroda is likely to give it an optimistic spin, though the debate is likely to intensify below the surface.
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