If the European Central Bank wants a shot at sorting out the euro zone’s financial problems, it should really give up tinkering with the short-end of the yield curve or buying relatively tiny amounts of assets that won’t do anything to increase the size of its balance sheet and get on with some proper sovereign bond-buying. That was the view of our guest this morning FOREX.com research director Kathleen Brooks. Kathleen, who also contributes to Reuters Opinion pages on a variety of subjects, said there was still a big hurdle to buying government bonds as a means of keeping borrowing rates low and encouraging the flow of credit to the real economy. Not all the members of the ECB’s policy-setting body, the Governing Council, agree with the idea, for starters. “Short-term yields in the currency bloc are already so low, the ECB should not target those, they need to target further out the curve to lower rates further, this would also send a powerful signal that (it) is going to suppress yields for the long term,” Kathleen said.
A recent Reuters poll of economists shows the market is pricing a 50-percent chance of so-called quantitative easing (QE) happening, up from a 40-percent chance in September. As for the ECB’s plan to increase its balance sheet by a trillion euros, in part by buying asset-backed securities and covered bonds, Kathleen said this wasn’t the way to go at all. “I don’t think that will do much to help the economy or boost the ECB’s balance sheet to 2012 levels, the rules over purchases are too stringent and the market is not big enough,” she said. The ABS market in Europe reached about 180 billion euros in issuance last year, compared to the U.S. market of 1.5 trillion euros. “As we know from the Fed and the BOJ – sovereign QE is the best way to go to achieve balance sheet adjustment,” Kathleen added.
Markets love a challenge and what better kind of challenge than testing the resolve of a central bank? Plus it makes for such great headlines. The Swiss franc hit a 26-month high against the euro yesterday, inching closer to the Swiss National Bank’s three-year old cap on the exchange rate. The SNB hasn’t exactly issued a Mario Draghi-style “whatever it takes” promise, but it’s been pretty clear that it won’t allow the franc to break below its self-imposed threshold of 1.20 francs per euro, which it set to stave off recession and deflation. “The last time they propped up the peg, there was some talk that they were buying EURCHF with one hand and selling EURGBP with the other. I think we’re seeing that borne out already in the recent declines in EURCHF,” our guest today, CMC Markets analyst Michael Hewson, said.
The last time the SNB stepped into the market to defend the cap was two years ago. It might find that more difficult to live up to that promise now, especially with the euro seemingly only capable of heading south right now. “The SNB is going to find it difficult to hold the line on EURCHF given that its reserves already amount to over 40 percent of euros,” he said. The SNB held 460.427 billion Swiss francs in foreign currency at the end of October, compared with 462.117 billion francs in September. This is almost double what they were when the SNB imposed its EURCHF limit. “The CHF crosses will bear the brunt if they show any signs of a crack in resolve,” Michael said. The SNB isn’t out of options, at least not yet. There might not be any Draghi-style pledges, but perhaps it might have a Draghi-style toolbox. “I’m wondering if we could see the SNB do negative deposit rates in an attempt to defend the peg,” he added.
Spanish bond yields are down today as the market shrugs off the results of the informal referendum in Catalonia on independence from Spain. Turnout was small as a percentage of the overall population of the region, but the undeniable fact is nearly 2 million people voted in favour of independence and the central government can’t very well ignore it, even if it did try to block the process. “This is a process or movement that has been building since 2010, when the Spanish constitutional court pared back key elements of a Catalonian statute of autonomy,” Aengus Collins, lead analyst for Spain at the Economist Intelligence Unit, or EIU, told us. “The direction of travel is clear, and ultimately the central government is going to have to respond more creatively than it has done up until now.”
Spanish bonds, on which yields are close to record-lows around 2 percent, underperformed most euro zone bonds last week in the run-up to Sunday’s ballot. The fear among the trading community was that a big turnout could stir up tensions between Madrid and a region which accounts for one fifth of the country’s economic output. The “consultation of citizens” in Catalonia follows a legal block by the central government of conservative Mariano Rajoy against a more formal, yet still non-binding ballot which regional leaders had been pushing for originally.
It was supposed to be boring. That was the feeling in the markets earlier today ahead of the European Central Bank’s November policy meeting. Yet ECB President Mario Draghi still managed to startle currency traders into pushing the euro to fresh 26-month lows after he warned there was room for the central bank to cut its forecasts for growth and inflation as the regional economy sputters. A Reuters exclusive story this week that highlighted the growing discomfort among the ranks of the ECB Governing Council over Draghi’s leadership style had already rattled the euro. Our guest this morning, Agenda Research economist Lorcan Roche Kelly, said while he might not be especially popular, Draghi isn’t going anywhere. “There is some discontentment with him, but there is no sign of a challenge to his leadership,” he said.
Super-Mario himself was keen to lay this idea to rest. For starters, we lost count of the number of times he said “unanimous” or “unanimously” in relation to questions about today’s policy decision by the Governing Council. “When we differ in our views and our policies … there is no drawing of a line between North and South. There is no coalition, not at all,” Draghi said in response to a question from a reporter on the Reuters story. We also couldn’t help but notice that Reuters ECB correspondent Eva Taylor, one of the co-authors of the article in question, was one of the last reporters to ask a question during the press conference. A coincidence? Probably, but this was not lost on the GMF community
The euro can’t seem to catch a break. The single European currency is on track for its first monthly rise in percentage terms since June (good for the eur-optimists) but is still only about 1 percent away from two-year lows against the dollar. Today’s aggravating factor was a media report that said at least 11 of the 130 European banks under European Central Bank scrutiny will fail the central bank’s stress-tests, the results of which will be officially known on Sunday. The ECB appealed for calm in the markets and basically said speculation wasn’t helpful, while our guest today, BNP Paribas group chief economist William De Vijlder, said the stress test, or Asset Quality Review (AQR) as it’s officially known, isn’t the be-all and end-all that some might be hoping for but will go a long way towards repairing something lost in the maelstrom of the global financial crisis: confidence.
“The ECB lending survey shows the balance between banks tightening versus easing has improved significantly and the balance between banks expecting pick-up in demand versus those expecting a decline has improved even more significantly,” William said. “However, to see this translated in real numbers, there needs to be confidence at the lender’s and borrower’s side. On the former, that’s where AQR can help, a bit.”
Today the World Health Organization declared Nigeria free of the deadly Ebola virus after six weeks with no new cases, an achievement with lessons for countries still struggling to contain the deadly outbreak. And hopefully it serves as something of a reality-check for countries where the media has worked itself into a frenzy about the potential for disaster. Our guest today, Reuters Sub-Saharan Africa bureau chief Pascal Fletcher, recalled the words one health worker said to him in the early stages of the current outbreak: “One Ebola patient is an epidemic”. While that might be true, outside the infection hot-spots of Sierra Leone, Liberia and Guinea, it’s business as usual. “The fear factor is very high, magnified of course by the media frenzy in the U.S. and in Europe; but things should be put into perspective; life does and must go on,” Pascal said. “For many people in Africa, worrying about Ebola is a bit of a luxury outside the core epidemic countries; so many people have enough to worry about just making ends meet in a continent where sadly poverty and disease are still part of the daily struggle, though things have been and are definitely improving.”
The news flow on the Ebola outbreak, the worst on record, seems more positive this week. The Spanish nursing assistant who contracted the disease in a Madrid hospital while treating a dying priest is expected to be declared free of the virus this week. Health authorities in the United States, where one person died from the disease in Texas and two nurses who treated him became infected, are putting together new care and prevention guidelines to stop the spread of the disease. Guidelines are all well and good but, ultimately, the only way to truly halt the virus, which has killed over 4,500 people in West Africa so far, is to keep the focus on Africa, according to Pascal. “All the efforts should be concentrated on eradicating this outbreak on the ground in the core countries; that is the only way to completely eliminate the risk of it spreading elsewhere in this highly-interconnected global village we now live in,” he said. Pascal went on to tell us that, in his view, the biggest contribution the developed world can make now is to get medical “boots on the ground” – supplying the staff to manage the patients to prevent the spread of the disease – backed by enough resources to build and supply the necessary Ebola treatment units, a big part of Nigeria’s success in ridding itself of the virus.
Of the mainstream commodities, oil is now 2014’s worst performer, having lost nearly 20 percent in the last six weeks, as investors, fretting about the prospects for global demand and the abundance of supply, have punished the crude market. The oil price, which is below $90 a barrel for the first time in two years, has unwound nearly half of the gains made from the depths of the financial crisis, to the four-year peaks seen in early 2012.
While lower oil prices — and the cheaper motor fuel prices that will ensue — might actually be exactly what the developed world’s cash-strapped consumer needs to start spending money, it’s inflicting undeniable pain on the oil producers. Each is waiting to see who will blink and cut first. Our guest today, Natixis head of commodities research, Nic Brown, said the squeeze extends well beyond OPEC and expects some projects in the United States, which is exporting more oil now, in the form of products like diesel, than at any time since the 1950s, to now be below cost. “We’d put (average) break-evens in a wide range, from perhaps as low as $55 a barrel to $85 a barrel, if not slightly higher,” he told participants in a multi-room chat with the Global Gold and Global Base Metals Forums.
There’s no denying there has been a shift in sentiment over the course of October. The data coming out of the likes of China and Germany, usually reliably robust, has been soft enough to spark some serious concern about the prospects for global growth. Add to that angst about apparently imminent interest rate rises in the United States, which threaten to drain flows out of the rest of the world and back into the dollar, and you have a pretty unappetising picture on the markets. Our guest today, Peter Westaway, chief economist and head of investment strategy for Europe at Vanguard Asset Management, says this gloom is probably overdone. “If you look back at the mistake investors have made over the last two years, it has been to continually expect rates to rise soon. And they haven’t. That is why we keep hearing policymakers … talking about rates lower for longer,” Peter said.
But the International Monetary Fund has cut its growth outlook, bond yields are hurtling back towards their recent lows, the currencies of “problem-child” economies such as the euro and the yen are at multi-year troughs against the dollar as the mood sours. The VIX index, which tracks volatility on options on the S&P 500 equities index and is often used as an investor “fear gauge”, is set for its largest annual percentage increase since 2008, having risen by nearly 30 percent – and most of that has materialised in the last six weeks. In the short-run, Peter says he’s optimistic in the sense that he doesn’t believe policymakers will raise rates prematurely. “I’d say I was a long-run optimist, where my take on the euro area has always been that in the long run, this (structural adjustment) will be good for Europe, but short run, it is a tough road with many mis-steps.”
The dollar is set for its largest weekly fall in nearly three years and, were this the euro or the pound, market-watchers might be a little more concerned about what that might be saying about rate expectations. Our guest today, CIBC’s head of currency strategy Jeremy Stretch, said the dollar’s bull-run that has brought it to 4-1/4 year highs this month isn’t in immediate danger of fizzling out any time soon. The minutes of the Federal Reserve’s September meeting, released yesterday, show the members of its rate-setting committee are struggling with how to come to grips with the dual threats of a stronger currency and a global slowdown. Jeremy said the temporary pullback in the dollar was more the product of disappointment that the Fed’s hawks weren’t more vociferous than of any perception that policymakers are rethinking the likely course of U.S. rates. “The Fed are just mindful of the view the more pronounced the dollar gain, the slower the rebound and CPI will be lower … Central bankers are paid to worry about risks and certain Fed members are just considering a new external risk,” he said. Economists had widely expect the Fed to introduce its first rate rise in nearly eight years in the first half of next year, but market pricing now indicates that could be as late as September.
The world’s most influential central banks appear to be parting company in terms of how they conduct monetary policy and the dollar has emerged as the major beneficiary of that divergence. The dollar has risen by nearly 7 percent so far this year, putting it on track for its largest yearly percentage gain in nine years. This development is a welcome one to the European Central Bank or the Bank of England, with their export-dependent economies to cater to, but it’s not exactly music to the ears of the Fed. “The US is not immune to what is going on elsewhere, although the degree of export dependency is relatively low. We are in an environment where many central banks have been encouraging weaker currencies versus the USD to boost exports and mitigate deflation,” Jeremy said.
This week, China has taken the boldest steps this year to revive its economy and ward off the threat of sagging house prices, by cutting mortgage rates and down payment levels for the first time since the global crisis of 2008. No one ever doubted the government’s commitment to achieve its set target of 7.5 percent economic growth, whatever the cost and Beijing’s tough response to the pro-democracy protests in Hong Kong that have brought tens of thousands to the streets in the last week highlights that commitment.
Hong Kong leader Leung Chun-ying defied the protesters’ demands to step down by Friday, with pressure also increasing from Leung’s backers in Beijing over one of the most serious political challenges they have faced in decades. Peter Ferdinand, associate professor of politics and international studies at the University of Warwick, told us this week the orthodoxy of the Chinese leadership is that the country needs economic growth first, and will develop “socialist democracy” later. “They think that premature democracy will be bad for growth – and if the demonstrations in Hong Kong lead to international damage to China’s economy, they will feel justified,” Peter said.