Week End Blog – Central Bank Headline Headaches!

· by · in FINANCIAL MARKETS, MACRO. ·

I start off this episode of the Week End Blog with a shameless example of self-advertisement. This week I made it to Business Insider’s list of ‘the 128 finance people you have to follow on Twitter.’ That’s not a bad achievement, now is it? Especially when you look up some of the other people on the list, which you can find here, by the way.

Enough already! This week, ‘lowflation’ was the main theme in financial markets. Confirmation that inflation is still way off target reached us from all over the globe. In China, inflation fell from 2.0% in August to 1.6% in September. Needless to say this was below expectations. Also, the headline CPI number has not topped 2% since July of last year.

China’s PPI number, reported together with the CPI data, doesn’t bode well either. YoY producer prices fell 5.9% in September, the biggest fall since 2009. Overcapacity remains an issue in China.

In the UK, inflation, again unexpectedly, fell back below the zero threshold. After a couple of months of hovering marginally above or at 0.0%, deflation re-entered the UK economy. Hence, the UK rejoined the global deflation list.

From a longer term perspective the fall in inflation levels looks pretty impressive. After being structurally too high between 2010-2012, inflation has now lingered in lowflation area for over a year. As The Economist neatly describes, the UK experienced a genuine price crash!

In the US inflation also turned negative, although at a rounded level CPI came in at -0.0%. An awkward gap has opened up between the core CPI, which rose to the highest level since July last year, and the headline CPI. This headline headache made a number of Fed policymakers question the appropriateness of a rate hike lift off this year.

Comparable to China, PPI numbers have been subdued in most parts of the worlds. From the PPI angle, significant inflationary pressures are not to be expected any time soon.

Central bankers worrying over inflation, it has become a familiar sight. And investors are comfortable adjusting to it. According to one measure, investors don’t expect the Fed to raise rates for another 7.5 months at least. This means the FOMC meeting of April next year is now the most probable time for the Fed to act. To put that into perspective: it has been just over a month when a September 2015 rate hike was still on the table.

With Fed members hinting a lower rates for longer, ECB members can’t stay behind, of course. ECB decision makers have hinted strongly at the possibility of more QE, either by raising the amount of bonds bought, or by continuing the program after September next year. Or perhaps a combination of both. ‘Squeezed’ between all these dovish comments, the EURUSD exchange rate has become a toy of monetary policy. Day-to-day movements can be, almost fully, explained by (changing) expectations about relative monetary policy going forward.

The increasingly dovish stance of central banks has provoked ‘routine patterns’ in financial markets to continue. In recent days volatility collapsed, equities are grinding higher, while government bonds yields are down. Will central banks do it once more?

Historically, it would be no exception, in any case, if stock prices went up from here. The graph below shows that the recent rebound in stock markets shows an eerie resemblance to the average, historical return pattern after a crash.

Finally, while stocks have historically gone up from here, the end of QE, or tighter monetary policy, is unlikely to be welcomed by investors. Over the last couple of years the S&P 500 index has gone sideways or down every time when the end of Fed QE was announced. With inflation going nowhere for now, the Fed could be enticed to keep rates lower for a bit longer!

 

Thank you for reading the Week End Blog. Enjoy your weekend!

One response to “Week End Blog – Central Bank Headline Headaches!”

  1. This week I made it to Business Insider’s list of ‘the 128 finance people you have to follow on Twitter.’ That’s not a bad achievement, now is it?

    Well deserved! van harte gefeliciteerd.
    Ik kwam vaak losse tweets van u tegen
    Toen kwam ik de blog en de notification service tegen.

    Prachtig, bedankt!
    Het voelt wel een beetje vreemd dat u zoveel moeite doet voor zoveel onbekenden. gewaardeerd wordt het in elk geval en blijkbaar niet alleen door mij.

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