Week End Blog – With Central Banks, (dis)inflation and QE

Another week in which central banks took center stage. Again, it became pretty clear that the performance of equity markets is still heavily impacted by the actions, speeches and ‘internal presentations’ of central bankers.

The big news this week was the Eurozone CPI number. Dragged down by energy prices, the energy component of the CPI is down 6.3% YoY, Eurozone inflation dropped to -0.2%. This was below expectations and also represents the first negative reading since September 2009. Interestingly, while most attention goes to the headline number, the core CPI actually ticked up 0.1% to 0.8%. Still, also way below the ECB target.

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Chances are we haven’t seen the low in the Eurozone CPI just yet. As mentioned above the energy component of the CPI is down 6.3%, while oil prices have more than halved. As the graph below shows, deflation could linger for quite some time.

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The upside of the deflationary environment is that central bankers around the globe rush to ensure investors they will do whatever it takes to stimulate growth and thus inflation. Yellen’s tone remained dovish, while Draghi continues his quest for QE. Hence, after a couple of shaky days stocks recovered from  their year-to-date losses.

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On Friday, Bloomberg published a story that ECB staff members presented ECB policy makers various quantitative-easing options, with up to EUR 500 billion of (investment grade) government bond buying. Such an amount would increase the ECB balance sheet by roughly a quarter.

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Although this is, of course, a serious amount of money, the ECB would remain dead last in the balance sheet expansion race. We should not forget about the other programs as well, but to play with the big boys the ECB would have to come up with something more ‘bazooka-like’.

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Meanwhile, bond yields are having a race of their own. Lower inflation expectations and the anticipated Eurozone QE are driving yields ever lower. Many short-term rates are already negative, and at this pace, 10-year bonds yields could be heading there as well. The table below gives a excellent overview of what is happening in bond yields right now. All time lows are hit almost every day.

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A big contender to win the race to the bottom is Japan. This week the yield on the benchmark bond with a 10 year maturity hit an all time low of just 0.26%! For reference, Japanese inflation stands at +2.4%.

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The upcoming QE program by the ECB already drove the euro to new lows as well. This week it matched the first quote that was ever given on the euro, just below the 1.18 level against the dollar. But, looking at the short-term interest rate differential between the US and Germany reveals the latest fall in the euro may be a little bit too much for now.

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With all the central bank activity going on, Greece was less dominant in markets than the week before. However, the issue is far from resolved and recent poll results showed that Syriza may have increased its lead. A ‘grexit’ is not imminent, but a messy debt financing cycle, which should start as early as February, is not unlikely.

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Perhaps the chart below could influence the election outcome in January, although I don’t think there are many Greek left with investments in either bonds or equity. Anyway, the trend is down.

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The same holds for oil prices. Although oil prices recovered somewhat towards the end of the week, the trend remains down. OPEC does not really seem to care and production continues to grow. Yes, there are many winners of lower oil prices, but don’t forget about the losers.

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The US job market is doing fine. After a stellar job growth in November (revised +353K) the nonfarms again beat expectations in December (+252K). Average hourly earnings, a gauge of wage growth, fell, however. A development the Fed will surely take into account. Also interesting, the Twitter forecast for the nonfarms beat the Bloomberg consensus forecast. I leave it up to you how to interpret this.

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Finally, it has been a while, bitcoin re-enters the Week End Blog. A nice chart by The Economist as a reminder that 2015 could indeed be a decisive year for the virtual currency. The number of transactions is up, but its value is down. Bitcoin was the worst ‘currency’ of 2014 (except for the fact it’s not really a currency).

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This wraps up this Week End Blog. Thank you for reading. If you have any remarks or questions please let me know (@jsblokland). Enjoy your weekend!

 

 

 

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