One of the themes of these times has been the concept of “currency wars” as various nations and currency blocs have sought to gain a competitive advantage. However yesterday evening and this morning have reminded us of the fact that we are being promised interest-rate wars in December. Last night saw the Vice Chair of the US Federal Reserve Stanley Fischer pump out the party line and indulge in some Open Mouth Operations on the subject of an interest-rate rise.
we have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to “just do it.”
Well this first bit is untrue as of course many people ( but not us) have been surprised by the fact that the Federal Reserve has not already raised interest-rates this year. Also “when we move” is intriguing for an institution where only one member has voted that way so far and nine including Stanley voted for unchanged. Perhaps Jeffrey Lacker is the persuasive sort. Thus we are left with Yazz on the prospects for interest-rates.
The only way is up, baby
For you and me now
However there was more and Bank of England watchers may have noted the use of the plural here.
What lies ahead? In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates.
No doubt he does speak to Bank of England Governor Mark Carney regularly although he may not be fully away of his propensity for “spinning around” and his own version of Open Mouth Operations.
The Mario Draghi version
Rather intriguingly ECB President Draghi has latched onto the the Fischer theme last night and decided he is in complete agreement with “begin gradually moving away from near-zero interest rates.” So let us examine the speech to to the European Banking Congress he has just given.
The level of the deposit facility rate can also empower the transmission of APP (Asset Purchase Program or QE), not least by increasing the velocity of circulation of bank reserves.
So he is signalling a likely change but whilst he is moving away from zero and thereby agreeing with Stanley Fischer I am afraid that he is singing along with the Monkees.
Goin’ down. Goin’ down.
If we look at the stream of hints that President Draghi has given us in recent weeks then initial thoughts of a cut to -0.3% are being replaced by thoughts of a cut to 0.4%. The German bond market seems to humming that tune now. From @FerroTV
German 2–year yield drops to a fresh record low
That is -0.39% now we see a theme of this blog, that negative interest-rates are on the march, increasingly comes to fruition.
Although it is hard not to smile as a past version of Forward Guidance implodes. At the European Banking Congress last year Mario told us this and the emphasis is mine.
The first step, as I said, was to lower overnight interest rates all the way to their effective lower bound – including below zero for the deposit facility.
What a difference a year makes! Are we now going to their ineffective lower bound?
Mario will have some “friends”
Such interest-rate hints from the ECB will put scowls on the face of a few central banks around Europe. A picture of his face is likely to go back on the dartboards of Sweden’s Riksbank, Denmarks Nationalbanken, and the Swiss National Bank as they mull having to cut interest-rates from -0.35% for the former and -0.75% for the latter two. Will we see someone cut to -1%?
Of course some of that is speculation but I doubt that many requests for leave on December the 3rd will be entertained at any of those institutions. It seems set to be a time for all hands on deck.
What else does Mario have in his locker?
One area where the ECB has been fairly consistent has been in its mantra that it can adjust its QE or APP program.
We consider the asset purchase programme to be a powerful and flexible instrument, as it can be adjusted in terms of size, composition or duration to achieve a more expansionary stance.
As we see more and more central bankers jawboning on the subject of market liquidity it is the size of QE that is the hardest to change on any large scale. Of course changing what is bought would be a help in that as for example Portugal has lots of debt the ECB could buy. But buying ever more government bonds would make those markets ever more illiquid and ever harder to shrug off protests that the lack of liquidity is caused by the same central bankers who pontificate on it. Accordingly an increase in the duration of the program seems likeliest to me beyond September 2016 as we mull the thoughts of a famous cartoon character.
On that subject you may be intrigued to note that the US Treasury Bond market seems to be setting itself for an interest-rate rise followed by QE 5 rolling down the slipway.
What else does Mario think?
The first message is a bit of back slapping and trumpet blowing.
Our measures have therefore clearly worked – in fact, they are probably the dominant force spurring the recovery that we see today.
So much for the falls in the price of oil and other commodities then. But Mario was determined to mine the same vein.
To give you a comparison, we estimate that in normal times our policy rate has to be instantaneously reduced by 100 basis points to see a similar impact on lending rates after such a short time period.
But more needs to be done and after all the hype comes a contradiction.
the present upswing which started in 2013 is the weakest euro area rebound since 1998.
Also we need to recall that the ECB is a central bank which prioritises its inflation target above all else.
The so-called core measures of inflation – which strip out volatile components – have also been drifting down since mid-2012 when the euro crisis hit its climax, and have been hovering around 1% for nearly two years………….Low core inflation is not something we can be relaxed about, as it has in the past been a good forecaster for where inflation will stabilise in the medium-term.
So at the cost of directly contradicting his predecessor Jean Clause Trichet Mario Draghi could not be clearer about his plans for December. Also by implication he is contradicting the words of Bank of England Governor Mark Carney when he told us that central banks do not make up their minds before policy meetings.
We have a potential clash of the titans on its way and of the two the likeliest move remains that of the ECB. After all it has backed up its rhetoric and promises with action whereas the US Federal Reserve has so far backed up its promises with more promises. Also even the US central bank which is often insular may note the strength of the US Dollar.
Of course the ECB has the benefit of having the first move in the chess game as it meets a fortnight or so ahead of the US Federal Reserve. That might be a long time for the Fed to twiddle its thumbs for although they could spend it trying to find out where the interest-rate rise button is.
Ironically such prospects reverse what happened in 2011 when the ECB raised its policy interest-rate twice (to 0.75%) whilst the US was busying itself with QE 2 and then Operation Twist. What happened next? Well remind yourself of the current ECB interest-rate…
Meanwhile the two central banks must be singing this Diana Ross song to the other.
Boy (Girl), you turn me
And round and round
Boy (Girl), you turn me
And round and round