The current European Central Bank’s asset purchasing program had it buying $80 billion in bonds per month until April 2017. No one expected this to be the end of the program, but the specifics of the new program would determine how markets would react. The media likes to put every central bank movement into a category of hawkish or dovish. Hawkish actions would be raising interest rates and lowering QE which is bearish for stocks and bonds and bullish for the currency. Dovish actions would be leaving interest rates low and keeping QE which is bullish for stocks and bonds and bearish for the currency.
This year we’ve seen the media describe the as Fed vacillating between being hawkish and dovish. In my opinion, the Fed is not changing its mind based on the data; it is dependent on the market. Therefore, its policy is not actually vacillating between being dovish and hawkish. In the grand scheme of things, every central banks’ actions for the past few years and for the next few years has been and will be dovish. I would describe the central banks vacillations as ‘more of the same’ instead of trying to qualify which direction it is in. If you are a day trader, then my characterization would be wrong because each move has a direct impact on markets. If you are looking to spot trends in policy to understand what direction the next large move in markets will be, then my description makes sense. It implies the central banks will maintain support for markets while changing policies on the fringes.
The statement by Draghi supports my claim because he said if "the outlook becomes less favorable or if financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation" then the ECB would increase the program again in terms of size and/or duration. To me, this makes the specifics of the policy immaterial because the ECB will support the market whenever it needs it. It is similar to the ‘Greenspan Put’ where Alan Greenspan would inject liquidity and lower rates in times of crisis. By buying assets and upping the purchases in times of duress, it’s like a parent promising to catch their kid if it falls off a bike while the kid is using training wheels.
The ECB buying assets at times when investors are buying as well doesn’t matter much. What matters is why the investors are buying; they are buying because they know the ECB will keep a lid on any problems. It makes bearish situations, like the Italian referendum, buying opportunities because investors know the ECB will step in. The ECB doesn’t even have to do much because its forward guidance makes investors naturally stabilize the market.
This is great in the short term, but catastrophic when confidence in the central banks ends. The analogy I will draw is a powerlifter who wears workout gloves during every practice session even though they are illegal (assume they are) during competitions. When the lifter takes off the gloves for the competition, his hands are ruined by the barbell and he can’t properly grip the bar. The benefits of avoiding callouses are lost and the ability to do well in the competition is lost even though he practiced every day. The ECB is preventing market corrections from happening, so the day volatility takes charge, investors won’t be able to handle it without panicking. All the minor corrections that should be occurring, will occur in one event.
Even though I said the specifics don’t matter because Draghi said he would increase the program to deal with risk, let’s look at what was decided compared to expectations. We have the 20/20 hindsight of knowing how the market reacted, so no analysis is needed to determine if the action was dovish or hawkish.
The policy was less QE for a longer period. The monthly purchases were lowered from $80 billion per month to $60 billion per month, but the program was extended until December. The quantity of assets that can be purchased was extended to avoid the ECB running out of bonds to buy. It’s debatable if this is a taper because although it is lower asset purchases, the amount can increase at any time. The point of a taper is to turn off the spigot, but if the spigot is allowed to last longer than it’s not really a taper. Draghi did not want this to be interpreted as a taper and I agree with him.
The market appears to agree with me and Draghi because stocks rallied, the Euro fell, and bond yields were stable. The DAX ended up 1.75% today and the FSTE 100 was up 0.42%. Both closed near the highs of the day. The 10-year German bund increased from 38 basis points to 45 basis points and then fell back to 38 basis points. Next it increased to 43 basis points and fell back to 38 basis points again. The EURO/USD rallied slightly initially before falling from about 1.08 to 1.06. These moves go along with the narrative that the decision was dovish.
They also follow along with my perspective that this was more of the same because the Euro continued its trend of weakening versus the dollar and equities continued their trend of rallying. The bund continued having virtually no yield. That’s what usually happens after Fed meetings. There is a head fake correction one way before the market extends the trend it was already in.
The first round of voting in the French presidential election is in April. This falls within the $80 billion purchasing period. Further rounds and a possible special Italian election will fall within the $60 billion period. However, it doesn’t matter either way because if a far-right populist wins, the ECB will stabilize the market with more bond buying. Politically, 2016 was a win for the populists worldwide; monetarily, it was a continuation of the same policies. I expect this trend to continue next year.
The December 2017 decision may lower bond purchases further, but continue the program. The only possible game changers which would shake up policy would be a global recession or the popping of asset bubbles. The issue is central banks are aiming to prevent that, so doing more of the same dovish actions has a self-fulling nature. It perpetrates a world with low productivity, low GDP growth, high stock prices, and low interest rates. It’s not an exciting world to live in for most which is why we see political backlashes.
Recent Comments