Call it “Whatever it takes” II.
Today, European Central Bank President Mario Draghi said that the EuroZone central bank “will do what we must to raise inflation as quickly as possible.”
I don’t expect that this promise, made in a speech in Frankfurt, will have the same electric effect as “Whatever it takes” I in July 2012. That promise reversed a plunging euro, pulled the bonds of Spain and Italy back from the brink, and set the stage for a significant recovery in the prices of euro assets.
This time I think the likely market reaction will be positive—that is the euro will move lower as the bank wants (it closed at $1.0656 down 0.68% against the dollar today) and financial assets will move higher (the German DAX is up 0.31% today)—the move will be much more modest. The likely actions from the bank are relatively modest in contrast to past proposals and the problems the central bank faces have proven to be very resistant to the bank’s solutions to date.
After today’s remarks by Draghi pretty much everyone has concluded that the bank will move at its December 3 meeting—even though hardline members of the bank’s board of governors such as Germany’s Jens Weidmann are saying no changes are needed now. The bank’s inflation target of 2% remains a distant dream with the current inflation rate in the EuroZone at just 0.1%.
The policy menu in front of the bank includes an expansion of the current program of bond buying from 60 billion euros a month to 80 billion or so; an extension of the life of the program beyond the current September 2016 limit, and a further drop in the bank deposit rate. In normal times the central bank pays a modest rate of interest on money that banks leave on deposit over night. These days the central bank charges banks that leave their money overnight 0.2%. It’s just about certain that the European Central Bank will take that negative deposit rate even lower to, say a negative 0.3%. Bond yields across the EuroZone are already falling even further into negative territory in anticipation of the central bank’s move. The yield on 2-year German government bonds fell to a record low of a negative 0.389% today.
There is a good possibility that rather than choosing from this policy menu the European Central Bank will implement all of these items. That would still fall well short of a “shock and awe” response to the current mix of extremely low inflation and tepid growth, but at this point it might be the best the European Central Bank can do.
The financial markets this afternoon read the minutes from the Federal Reserve’s October 27-28 meeting and concluded:
- That the Fed will raise interest rates for the first time since 2006 at the October meeting.
- That when the Fed says it will raise rates gradually, it means very slowly indeed.
The increased degree of belief in a December move on interest rates comes from language that the Fed inserted into its October post-meeting statement that “it may well become appropriate” to raise the benchmark lending rate in December. The minutes said that “Members emphasized that this change was intended to convey the sense that, while no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting.”
According to a headcount included in the minutes, some Fed members said that economic conditions for increasing interest rates “had already been met.” Others—“most participants,” the minutes said, estimated that conditions “could well be met” in December. A third group, “some participants,” the minutes noted, “judged it unlikely that the information available by the December meeting would warrant” a rate increase.” In my opinion data since the meeting on the strength of the jobs market and the economy and on inflation have argued in favor of a December move.
Participants in the meeting “generally agreed,” the minutes said, “that it would probably be appropriate to remove policy accommodation gradually.” The minutes added, “It was noted that the beginning of the normalization process relatively soon would make it more likely that the policy trajectory after liftoff could be shallow.” After a staff briefing on the equilibrium real interest rate, Fed members discussed the possibility that the short-run equilibrium interest rate would remain below levels that were normal in previous business cycle expansions.
Today Mario Draghi can’t talk the EuroZone up; more stimulus coming in December from European Central Bank
In July 2012 European Central Bank President Mario Draghi talked EuroZone bonds and stocks up by promising to do whatever it took to save the euro.
Today, Draghi’s signal that the European Central Bank would step up stimulus in December couldn’t stem further declines in EuroZone stocks and it didn’t do much for the euro either. The Euro Stoxx 50 index was down 1.78% for the day; the French CAC 40 index was off 1.94%, and the German DAX fell 1.15%.
The euro dropped as low as $1.07 before rallying slightly.
The weakness in the EuroZone extended to U.S. stocks and global commodities The Standard & Poor’s 500 stock index closed down 1.40%. Copper hit its lowest price since 2009.
The iShares MSCI Emerging Markets ETF (EEM) fell another 0.96% bringing its return for the year to a negative 12.79%. Brazil’s real, Colombia’s peso and Russia’s ruble were all down today by at least 1%.
Draghi had said today that downside risks in the EuroZone were “clearly visible” and that the central bank will study increasing the size and duration of its program of quantitative easing at its December meeting. The euro overnight index average has priced in an almost 100% chance of a December cut in European Central Bank deposit rates of at least another 10 basis points. (100 basis points make up 1 percentage point.) That rate, what the central bank pays banks to deposit funds over night, already stands at a negative 20 basis points meaning that banks have to pay the European Central Bank to leave cash on deposit.
Inflation in China at the consumer level rose in October at just a 1.3% rate year over year. That, the National Bureau of Statistics said on Monday, was the lowest rate since May and well below the 1.6% rate in September. Economists had expected an increase of 1.5
A truckload of implications (or at least five) follows from this number.
First, combined with the disappointing showing on exports and imports in data released over the weekend, it reinforces forecasts of slow growth in the global economy. The fear of slow global growth has led to another day of declines in emerging markets. The iShares MSCI Emerging Markets Index ETF (EEM) was down another 0.38% on Monday.
Second, with inflation in China so low, the People’s Bank of China is relatively free to cut interest rates, reduce bank reserve requirements, and otherwise stimulate growth in the Chinese economy. I think the Chinese markets will start to anticipate some or all of those measures in fairly short order. (Think possible short-term rally.)
Third, with low or no inflation in the global economy, there isn’t anything that I can see that stands in the way of a stronger U.S. dollar. (The U.S. dollar, in fact, hit a six-month high against the euro on November 9).
Fourth, with a stronger dollar and lower global growth expect weaker commodity prices. Oil was up slightly today as of 3 p.m. in New York time after days of decline but copper was down 0.47%.
Fifth, a stronger dollar means more cash flowing into dollar assets, which is likely to damp increases in U.S. interest rates when/if the Federal Reserve moves. The yield on the 10-year U.S. Treasury held steady on Monday at 2.31%.
If the Federal Reserve’s decision on raising interest rates in December—or not—is data driven, then consider the decision done.
Today’s report from the Labor Department, showing that the U.S. economy added 271,000 jobs in October provides all the data the Fed needs to raise interest rates for the first time since 2006 at its December 16 meeting. The increase was the biggest monthly jump in 2015 and easily exceeded the median forecast of an 185,000 increase among the economists surveyed by Bloomberg. Revisions to weak August and September gains amounted to just a paltry 12,000 jobs but I don’t think that matters in the face of the October gains,
Besides the jump in employment, October also showed a hefty 0.4% increase in average hourly earnings from September. Pay for workers is now up 2.5% in the last 12 months—that’s the fastest rate of increase in six years.
The official unemployment rate fell to 5% and the full unemployment rate, which includes discourage workers who have stopped looking for work and workers with part-time jobs who would prefer full-time work, dropped to 9.8%, the lowest level since May 2008. The labor participation rate stayed steady at 62.4%.
The market reaction was predictable. The dollar rose against 15 out of 16 major global currencies. Commodities fell on the stronger dollar with U.S. benchmark West Texas Intermediate dropping to $44.46 (down 1.64%) and Brent falling to $47.59 (down 0.81%). Gold declined 1.38% and copper lost 1.5% in London.
The U.S. stock market was relatively unchanged as gains in bank stocks offset losses in other sectors. (Banks show higher profits on higher interest rates.)
Emerging market shares as measured by the iShares MSCI Emerging Markets ETF (EEM) were off 1.4%.