A cut of the main lending rate in the euro-zone could have a very limited impact, so Draghi and his colleagues at the ECB might try other means before making this move, says Simon Smith of FxPro. Also Mark Carney’s BOE has a fine balancing act of preventing from the headwinds of QE tapering in the US from pushing yields higher.
In the interview below, Smith also discusses the Fed’s considerations regarding tapering, the impact of the new Fed Chairman and the next moves for the Aussie.
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.
ECB and rates
As always, there is a delicate inter-play between the ECB and national governments. Draghi has made clear (and his predecessors) that monetary policy can only do so much and they need to sort their own issues out. There have been some better signs in the Eurozone economy more recently, but austerity, weak growth and high unemployment continue to constrain the periphery. I don’t think a rate cut is yet a done deal, largely because the impact is unlikely to be that great, so the ECB has focused more on other measures (deposit rate cut, forward guidance) that may squeeze more out of the current situation.
The statement after the July meeting made particular reference to market expectations of future policy, embedded into short-term interest rates, which then naturally spill down the curve to longer-term rates. There is a certain inter-dependence between global interest rates, so this was more aimed at the fact expectations had increased for higher official rates in the UK, but this coming largely from the backdraft of the move higher in US interest rate expectations. In theory, a central banker’s ability to influence long-term rates (in a non-QE world) is not that strong, because there are so many other factors that influence them, not least the level of overseas yields. In summary, QE will continue to exert downward pressure on yields, simply by the fact that the supply of government bonds available in the market is lower than would otherwise have been the case. For now, it seems that Carney wants to insulate the UK from the winds towards higher rates coming from the US.
US and tapering
Tapering is not yet a done deal for September, although I believe that is when the Fed would like to reduce the monthly pace of purchases by around USD 20bln. But they need to be sure. On many levels, it would be very disruptive for markets if the Fed has to backtrack on any tapering, so when they take the first step forward, they need to be as sure as they can be that they will not have to take a step backwards at some point.
The feeling I have at the moment is that it should have more impact, but in all likelihood it won’t. Compare this to when Greenspan left in 2006. He was revered by markets (hindsight has judged things differently), but at the time the Fed had little impact on long-term interest rates (as excess savings from China piled in), which was partly how the problems of the credit crisis grew. Now we have a Fed that is (and has been) very active in many markets, with these activities supporting financial assets across the board. But there is not the same focus or fear on the change of leadership. That’s partly because Bernanke has a less domineering hold on policy vs. Greenspan, which is a good thing. Yellen will be slightly more dovish, more consensus driven. I imagine Summers would be a bit more of an unknown quantity from a monetary policy point of view, but more likely to rock the boat in terms of more radical policy direction. But for now, I have to be honest and say the impact on the dollar is probably too early to call, but my gut feel is Summers would be more dollar positive.
The comments from Stevens earlier did not really depart from the tone of the recent statements, so saying that the inflation outlook still allowed for lower rates if warranted. I think an August move now seems pretty likely. The latest inflation data was relatively tame and should offer the scope for a cautionary 25bp lowering to 2.50%. Naturally, the underlying risks in China also argue for a cautionary easing to ensure that Australia is better placed to weather further headwinds from there. AUDUSD and more so AUDZND look poised for further downmoves.
Further reading: Falling inflation could push QE tapering towards late 2013