The Global Markets Weekly – 12/12/16

Posted December 12, 2016 by rvillareal

ECB Tapers, and Doesn’t Taper

Wary that markets cannot be trusted to smoothly absorb a taper, Mario Draghi and the European Central Bank pulled off a bit of monetary sleight of hand, both tapering the flow but enlarging the ultimate stock of planned purchases, an “enlarging taper”, so to speak. The ECB extended its bond purchase program for nine months through December 2017, but scaled it back to a pace of €60B a month (from €80B), all the while stressing the plan might be extended in size or duration if conditions warrant. The extension is cumulatively larger than the six-months-at-€80B investors were expecting. After an initial shakeout, short term yields were steady to lower, the euro lower, and stock prices higher to end the week. Draghi even indicated his working definition of “taper” is to outline a path to zero purchases, so this is isn’t even a taper despite the reduction in the pace of purchases—quite the trick!

Semantics aside, the combination of moves does allow a degree of flexibility if conditions deteriorate, and an out if conditions continue in a manner that suggests above-trend growth and rising inflation. DE believes the evolution of recent economic data points to an increasing likelihood of conditions in which markets will be ever more skeptical of the need and/or efficacy of bond purchases, save for fresh deterioration in financial market conditions (perhaps best addressed by the OMT program rather than the broader brush of the asset purchase program).

On the efficacy front, two years into the program, current-year inflation is expected to be over a percentage point below what was forecast when the program started, while cumulative GDP growth has overshot expectations. We remind investors the Eurozone is experiencing an inflation backdrop similar to the rest of the industrialized world, and there is a growing sense that the logic in how or why further bond purchases should boost inflation has broken down. At least, save for (possibly) helping to provide downward pressure on the currency and even then, this affects the price level rather than the underlying inflation trend.

Turning to the U.S., the first Fed hike of 2016 will come this week, a year after liftoff. The meeting will be important for fresh forecasts and a dot plot update, the hike already fully priced. The furious rally in risk assets, rise in Treasury yields, and dollar strength suggest markets see a regime shift, but FOMC officials have so far indicated they’ll need to see more concrete economic plans to shift their policy stances (DE goes into more detail on Trump’s infrastructure plans in the Focus section within). Still, we are likely to see modest nudges toward DE’s expectations for higher-than-consensus growth projections, inflation, and rate path.

• S.: Clear highlight is the FOMC meeting and statement (Wed), with the Chair’s press conference, and updated economic projections and “dot plot” providing plenty of material. Economic data include November retail sales (We), consumer prices (Th), housing starts (Fr), and industrial production (We).
• Eurozone: The coming week will provide data covering many issues that the ECB glossed over in its latest assessment. Still-solid PMI readings will continue with the December flash updates (Th), the question being price pressures. Better readings are anticipated for both, likely to be reinforced by more solid Employment data (Tu).
• UK: The BoE MPC verdict (Th) will include a policy hold with a neutral stance reiterated, while data are likely to show the impact of the falling pound, including firmer underlying CPI numbers (Tu), headline rising to a fresh two-year high.
• Japan: The Q4 Tankan Survey is (Tu) is a key indicator for the Bank of Japan, gauging growth expectations and business confidence. Yen weakness and the recently introduced fiscal package may help the measure rebound after a weak Q3.
• China: November industrial production is likely to hold steady at above 6% y/y, while retail sales accelerate (both Tu).
• Other Central Banks: Central banks in Russia (Fri), Indonesia (Thu), Korea (Thu), Chile (Tue), and Mexico (Thu) meet to set policy. Inflation in Russia is decelerating after the ruble-induced 2015 rise, falling back to 5.8% y/y in Oct. A policy rate at 10% will come down in 2017, but perhaps not this week. Accelerating inflation and a weak peso will lead to another hike for Mexico. Growth expectations have tumbled, the outlook freshly in doubt.

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