The last few trading days provided no respite to investors who by now are likely becoming more and more accustomed to the increase in volatility and the challenging market conditions. Commodities, emerging markets slowdown, China related worries, auto scandals, geopolitical threats and currency wars all remain prevalent themes as they fail to find a definite response.
However, the longer these take to resolve the more evident it becomes that these might evolve in more than transitional shocks and hence, bear consequences on the fiscal and monetary policies. This is apparent in the shift downwards in European and US government yields, with the latter now pricing in fewer rate hikes over 2016.
Meanwhile, just yesterday, ECB released its account of the December meeting and reading through it one would say that recent developments should not be without consequences should they persist. To start with, the members of the Governing Council pinpointed at that moment that whilst the domestic economy appears on track to consolidate its cyclical recovery, the external developments are concerning and poise downside risks: “At the same time, it was mentioned that some indicators in the latest data suggested that the slowdown in emerging market economies was bottoming out and that world trade was starting to improve. Earlier concerns about developments in China in particular, following the stock market fall in August 2015, had not been borne out. Thus, a case could be made that the balance of risks had not deteriorated and had perhaps even become less negative. However, it was also argued that, even if the downside risk of developments in China was no longer considered to be acute, downside risks related to emerging markets more generally still needed to be taken seriously, both from a more medium-term perspective of the global financial and credit cycle and also in view of the vulnerability of some countries to increasing interest rates in the United States and related spillovers.”
Another noteworthy consideration might be the recent slump in long term inflation expectations although yesterday’s release shows that ECB has grown increasingly sceptical regarding the reliability of market based measures of such expectations.
Does this mean that ECB will soon expand its Quantitative Easing (QE, i.e. bond buying) programme? Personally I think that such a decision might not be forthcoming as the minutes of the December meeting show that the members discussed at length the fact that monetary policy alone cannot solve the region’s problems and that potential growth has to rebound to support the debt overhang in a number of countries.
On a related note, the central bankers emphasized that “the institutional and political framework of the euro area had so far not produced the kind of supply-side incentives that would be needed to spark private consumption and business investment in a significant way.”
Furthermore, it was suggested that yields might have reached a floor “According to some analysts, the steepening of the yield curve indicated that expectations of a deposit facility rate cut outweighed those of an enlarged asset purchase programme (APP). A second possible explanation was that some investors appeared reluctant to engage in purchases of longer-dated bonds at current low yields.”
Overall, the bar for a new round of QE seems to be high as the minutes bluntly state “purchases of sovereign debt, while considered to be a legitimate monetary policy tool, were seen to be associated with significant risks and side effects, and should therefore be kept in reserve as a contingency measure in case of extremely adverse developments, such as deflation, and should not be used as a means to fine-tune the inflation outlook.”
In view of this, I would expect the European yields to continue to range trade, with significant rebounds apparently unsustainable amid persistent worries regarding global growth. To put it differently, even though it is not clear that the latter will trigger fresh money printing, they underpin the fundamentals backing the current low yields.
Have a nice day!
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