by Michael J. Howell8. July 2013 22:23Two conclusions emerge from recent US and European Central Bank policy comments: (1) the Fed seeks to clearly distinguish (a) 'forward guidance' on Fed Funds from (b) QE, which determines the risk premium on bonds. Thus taken together forward guidance and QE determine bond yields. However, contrary to popular belief we believe that QE raises and does not reduce bond yields. Rather it reduces all other risk premia. The Fed by seeking to taper QE is trying we believe to stop the hunt for yield and likely wants to fatten 'too low' risk spreads on instruments such as junk debt, (2) the decision by the ECB and BoE to include 'forward guidance' is an interesting step. The ECB is admittedly using more 'words ' and according to our earlier points cannot control risk premia without QE. Nonetheless, the important thing here is that a European 'forward guidance' clearly opens the way for monetary policies in the US and Europe to formally diverge significantly. This could be key in 2014.
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Tags: Central Banks, QE
by Michael J. Howell8. July 2013 22:09Two conclusions emerge from recent US and European Central Bank policy comments: (1) the Fed seeks to clearly distinguish (a) 'forward guidance' on Fed Funds from (b) QE, which determines the risk premium on bonds. Thus taken together forward guidance and QE determine bond yields. However, contrary to popular belief we believe that QE raises and does not reduce bond yields. Rather it reduces all other risk premia. The Fed by seeking to taper QE is trying we believe to stop the hunt for yield and likely wants to fatten 'too low' risk spreads on instruments such as junk debt, (2) the decision by the ECB and BoE to include 'forward guidance' is an interesting step. The ECB is admittedly using more 'words ' and according to our earlier points cannot control risk premia without QE. Nonetheless, the important thing here is that a European 'forward guidance' clearly opens the way for monetary policies in the US and Europe to formally diverge significantly. This could be key in 2014.
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Tags: Central Banks, QE
by Michael J. Howell13. February 2013 12:19We do not accept the argument that the ECBs operating procedures are so different from the Fed and the BoE that a drop in the size of their balance sheet can be read bullishly simply because it supposedly reflects less take-up of distressed borrowing by banks. Moreover, we cannot see how arguing that the EONIA lending rate lies ‘close’ to the deposit rate floor indicates abundant liquidity. First, ECB balance sheet contraction proved the critical signal for the last crisis and low EONIA rates did not help. Second, the Eurozone money markets are not functioning. Problem banks are still unable to get funding and are forced to borrow at higher rates. Third, in the post-Lehman Crisis World where Central Banks increasingly operate interest rate corridors between lending and deposit rates they are able to control both the level of interest rates and the volume of liquidity. In the US and UK, Central Bankers now realise that greater volumes of liquidity decrease market interest rates. Thus, by flooding the system with liquidity, the Fed has successfully pushed investors back into risk assets. In short, the volume of liquidity maters, and matters a lot. Falling ECB liquidity from E1.67 trillion to E1.5 trillion is thus a bearish and NOT a bullish sign.
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Tags: ECB, Central Banks
by Michael J. Howell11. February 2013 12:43Both the ECB’s rhetoric and its actions are strangely out-of-step with the trends elsewhere. Eurozone is again heading for the buffers and the odds of another bout of market volatility have jumped according to our latest liquidity data. The ECBs monetary stance is strangely conventional at a time when more unconventional thinking is needed. Gross liquidity provision, which gives a better indication of support for Europe’s banks, slid back to E1.5 trillion in early February 2013 from E1.67 trillion last June, and the growth of base money has slowed sharply to pedestrian annual rates. More dramatically, our monthly index of ECB liquidity provision plunged to 6.3 (‘normal’ range 0-100) at end-January 2013 from a whopping 97.4 in June 2012. This has all the ‘fire-fighting’ hallmarks of the ECBs previous crisis responses: react to banking strains by throwing liquidity into markets and then progressively withdrawing it over following months as the crisis abates. Until the next time!
We restate our end-2012 comment that, in our view, the risks in the Eurozone in 2013 far out-weight the potential rewards. This was not the case for 2012, where the reward/ risk ratio was extremely favourable and the chances of some ECB action high. The problem 12 months on is exacerbated by the recent Euro strength and notably the near 25% rally versus the Yen. Germany has been the rock that has supported fragile European business over the past year, but this latest loss of competitiveness will not help German export performance. Europe’s financial problems are all about lack funding rather than insolvency: a less active ECB and a declining pool of German savings will again heighten these problems.
by Michael J. Howell21. December 2012 12:20We celebrated just more than a year ago the appointment of Draghi at the ECB to continue the good works of Bernanke at the Fed and Svensson at the Swedish Riksbank. Now Carney is slated to take-over the helm of the Bank of England, and rumours suggest that new Japanese PM Abe will turn to Iwata to lead the BoJ in 2013. These pro-employment CB changes are as significant as the selection of anti-inflation Volcker to head the 1978 Fed. The effect on the equity markets in 2012/13 may not be as dramatic as the impact Volcker had on the bond markets thirty years ago, but the positive effect will be felt.
This revolution attacks MV, i.e. money times velocity. Get M up via QE injections and raise V by creating inflation expectations via 'forward guidance', the Evans Rule (e.g. keeping rates low until unemployment drops below say 6,5%) or by weakening the US$. Taken together the latter are like having a nominal GDP target, or much as Carney as recently mooted for Britain.
All-in-all, given the well-known correlation between nominal GDP growth and nominal bond yields, this is poor news for global bonds. We expect yield curves to steepen. Normally this is bullish for other risk assets. The key to this puzzle may be Japan's JGB market. Investors must watch this bellwether in 2013 for confirmation that the new Central Bank Revolution is working its magic.