Global policy-makers get the message

Global policy-makers get the message
07/06/12 @ 06:33 GMT by Michael Derks, Chief Strategist

Rattled by May’s market madness, global policy-makers have finally started to show that they get the message, although their words will need to be followed by strong action before too long. Although the ECB was not decisive enough for our liking given the gravity of the situation in Europe (see below), at least Mario Draghi promised to act if the growth outlook worsened. Fed Vice-Chairman Janet Yellen conceded last night that the American economy was ‘vulnerable to setbacks’ and might require additional stimulus: Fed Chairman Bernanke will likely reinforce this point when he testifies to the Joint Economic Committee later today (see below). China in particular has implemented significant extra stimulus over recent weeks in response to their worsening growth performance; India has vowed to raise infrastructure spending to boost their ailing economy; and the RBA has lowered rates by 75bp over the past six weeks. Also, the BOE could decide to expand their asset purchases program when they meet this morning (see below). In response, the major American and European bourses were up more than 2% yesterday, Brent is back above USD 100 a barrel, and both the yen and the dollar have given back some of their recent gains. The euro suddenly looks a little perkier, notwithstanding ongoing concerns over both Greece and Spain.

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Commentary

The BOE must be brave. The Bank of England announces their interest rate decision at midday (UK time) and whilst rates are expected to remain on hold, a further expansion of the Bank’s quantitative easing policy is a distinct possibility. Since the Bank re-started the program back in September, it has been in the market almost on a weekly basis, buying on average GBP 400mln of gilts. Purchases ceased in the first week of May, so this has been the longest period for 8 months that the Bank has not been buying bonds. But the Bank must feel as if it has been pushing on a string in recent months, the economy having fallen back into recession and lending conditions still worsening overall. Recent data also showed mortgage rates rising (to a 1 year high on 2 year fixed) and consumer lending figures showing the largest fall in credit card lending for over 5 years. To make matters worse, the ill-winds from the Continent represent a significant ongoing threat to the UK economy. Further QE from the BoE is more likely than not at this juncture and an announcement to this effect today would not be inconsistent with the recent data and wider global risks.

Draghi is too defensive. The single currency was justifiably disappointed by the lack of any real urgency from the ECB at yesterday’s meeting of the Governing Council. The refi rate remains on hold at 1%, and more LTROs are simply being ‘examined’. The only announcement of note was that the ECB was extending full allotment at refinancing operations through to 15th January 2013. Draghi did at least observe that the downside risks to the economic outlook had worsened since the last meeting, perhaps setting the scene for further measures at some future point. Notwithstanding the limited options now available to the ECB, it was still remarkable not to see more from them given the depth of the crisis afflicting virtually the whole of Europe.

Ben must start up the helicopters. Today’s testimony on the economic outlook before the Joint Economic Committee of Congress is a critical opportunity for Fed Chairman Bernanke to indicate his potential support for additional quantitative easing. He may not be completely convinced just yet that it is necessary, but nevertheless he must at least put it on the table as an option. Notwithstanding the partial improvement in risk appetite observed in the first half of this week, the fact remains that global economic and financial risks loom large, especially out of Europe. Although the US economy has had a respectable first half, nevertheless it does appear that momentum has slowed during the current quarter. Fed Vice Chairman Janet Yellen stepped forth overnight, claiming that the economy may require additional stimulus and that it was still vulnerable to setbacks. Clearly, the internal policy debate on further measures is underway. Yesterday, for instance, Chicago Fed President Evans delivered an impassioned plea for ‘extremely strong accommodation’. In contrast, St Louis Fed President Bullard urged for more time to assess how the economy is performing. Notwithstanding the decline in oil prices and the reduction in US long term interest rates over recent weeks, it would be surprising if the Fed did not implement either more outright QE or another round of twist operations before too long.

Canada as an exception. With most major global central banks contemplating additional steps to ease monetary conditions in their local economy, the hawkishness of the BOC is definitely something of an exception. While acknowledging that global economic and financial conditions had worsened in recent weeks, Governor Mark Carney claimed yesterday that ‘some modest withdrawal of the present considerable monetary policy stimulus may become appropriate’ in the months ahead. Policy-makers in Canada are concerned that the modest excess supply that exists in the economy will progressively be absorbed should the recovery continue as it has done. Jobs growth in recent months has been incredibly strong, while the housing sector is enjoying decent growth as well. Also, lower energy prices and the lowest bond yields since records began are providing some additional stimulus for the economy.