Introducing Quantitative Easing in the euro-zone is complex just by the nature of the legislation and underlying capital markets, so any version of QE in the Eurozone is going to be fractured and of limited effect, says Simon Smith of FxPro.
In the interview below, Smith also discusses at which point the current Ukraine crisis could have a meaningful impact on markets, the “6 months” comment by Yellen and more topics.
Simon has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. He has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. Simon holds an MSc. in Economics from the University of London and a BSc. from Brunel University.
- Ukraine is back in the headlines. Can this have a meaningful effect on the franc, yen or other currencies?
To a degree, but the past few sessions have been something of a conundrum. We’ve seen equities weaken in the wake of the latest US labour market data, but at the same time, commodity currencies have done well, together with emerging market currencies, so equities seem to be saying one thing and currencies something else. We have seen the yen and franc stronger, but I am not sure it can be seen as a meaningful impact. There is likely a tipping point though, should the impression build that Russia starts more sustained incursions into the mainland. I would see that as being the point where the more meaningful impact on safe haven currencies starts to take effect.
- Draghi placed QE on the agenda. In what form could a euro-zone QE program work?
The form has to be different. Firstly, in contrast to the US, the Eurozone is much more reliant on the banking sector, rather than capital markets. The Fed was easily able to intervene in the mortgage backed securities market because it is a very deep and liquid market. The same naturally holds true for the US bond market. This is combined with the fact that it is a single currency area with many different countries, with diverse and illiquid bond markets. Intervening directly (non-sterilised) in the bond market remains difficult, especially given that the ECB is outlawed from monetary financing of government debt. The ECB justified the SMP and prior OMT on the basis that they were supporting the monetary policy transmission process. At the end of the day, any version of QE in the Eurozone is going to be fractured and of limited effect, just by nature of the legislation and underlying capital markets.
- So far, US job growth seems to be following the script. Do you expect the Fed to end QE in October and hike in April after Yellen’s comments? What factors should we be watching?
I don’t know that we can put too much emphasis on Yellen’s comments at her first post-meeting press conference. The impression I got was that she was finding her way in this form of communication and was too forthcoming in trying to answer questions. Monetary policy is always uncertain, but the unconventional measures from which the US is slowly exiting are dogged with even more uncertainty, so probably the only near certainty is that it won’t take 6 months between tapering ending and tightening starting. Even though the language may have been softened, the labour market remains pretty key given that this was the element that was lagging the recovery in the broader economy. There is also business spending, because once firms are investing, then this gives a greater underlying belief that the recovery is being seen as sustainable and that employers have confidence in it. We saw a decent bounce in Q4, but need to see this sustained to have more faith in the sustainability of the recovery.
- Do you expect the Bank of England to change its policy at one of the upcoming rate decisions or in the May Inflation Report?
No. What they did the February Inflation Report was to confuse market with an updated forward guidance policy reliant on such indeterminate factors such as output gaps, which means that the policy backdrop is even more confusing that before. This gives the BoE some time and also flexibility. Things have turned around. We previously had a weak economy and stubbornly high inflation. Now the economy is strong and inflation has moved below target. Given that the Bank chose to adjust rather than ditch forward guidance in February, it is difficult to see them changing the backdrop again in the coming 1-2 months and to a large part, the data does not warrant them doing so.
- Forex volatility has not been extreme of late, to say the least, despite monetary policy divergence. What could push volatility higher?
The issue is that we are in unconventional times. Whilst we do have diverging underlying intentions from central banks, which should be positive for currency trends, the fact is that we are still dealing with unconventional monetary policy measures for the most part, rather than changes in actual underlying central banks rates. So the impact on currencies is reduced but is also more uncertain. Just look at the single currency for a recent clear example of how the currency can move against what conventional thinking would suggest, most pertinently with last November’s easing. That said, there is always a reason, with the contraction of the ECB balance sheet into year-end accounting for much of the euro strength.
Further reading, the previous interview with Smith: Attempts to talk down the euro unlikely to succeed; Decent chance of BOJ action
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