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A Dovish Surprise At Jackson Hole?

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Toward the end of this week investors’ and market participants’, or at least those that aren’t still on summer holidays, interest turns to the Federal Reserve’s annual symposium in Jackson Hole, Wyoming. ECB President, Mario Draghi’s speech, scheduled around lunchtime on Friday, is highly anticipated. The Jackson Hole meeting has particular credence, as it has in the past given a platform for central bankers to provide guidance to markets through the financial crisis – particularly with respect to quantitative easing. 

In 2014, Draghi used his speech at Jackson Hole to pave the way for QE in Europe by pledging to use ‘all available instruments’ to stave off deflation. In March 2015, the ECB started its quantitative easing programme. Purchases were initially €60bn per month and subsequently increased to €80bn per month. There will no doubt be a relative amount of central banker backslapping as this policy has contributed to stabilising the region’s economy; the Eurozone’s jobless rate has fallen to 9.1%, a level not seen since the beginning of 2009 - at the 2014 meeting unemployment was 11.5%. Eurozone inflation is also steadily improving. With the inflation target of just below 2%, Draghi will be encouraged to see inflation at around 1.3% now versus 0.4% prior to QE. Growth has also doubled in this period to its current 2.2%. 

The question now becomes - how does Draghi successfully communicate to the markets a normalisation of ultra-loose interest rate policy starting with a reduction in the monthly QE asset purchases? Draghi rattled markets with a speech at a banking conference in Sintra, Portugal in June this year (see June commentary - ECB Taper?) and will no doubt be keen to ensure the same does not happen again. Members of the ECB spent the days after the Sintra speech reassuring markets that QE tapering wasn’t coming quite yet. Indeed speaking in Lindau, Germany this morning, he made no reference to how the ECB would or might adjust policy to the considerably improved economic data across the Eurozone. Hence the anticipation that any mention that provides guidance will be pounced upon by markets be it at Jackson Hole or a later date.

In July, Draghi said the ECB’s governing council will decide on QE at one of its 7 September or 26 October meetings. At present, the programme runs until December, with the expectation amongst most commentators that the programme will run well into 2018. However, until such time that the intentions of the central bank are stated, there will be considerable conjecture and potential knee-jerk market reaction hanging on Draghi’s every word. Given market reaction to the topic so far, the ECB is likely to proceed very cautiously in how it communicates and executes QE tapering. This is reinforced by the minutes of the July ECB meeting, which showed policy makers concerned about the euro’s gains as the market anticipated tapering. The euro is up some 12% against the dollar so far this year (latest 1.1785) and, as any Brit holidaying in Europe will have noticed, through 0.9200. A stronger euro acting as a deflationary pressure is certainly something the ECB is keen to avoid. 

Political uncertainty in the Eurozone has certainly not taken up the column inches it did at the beginning of the year when the western political status quo seemed to have fallen to a rise in populist revolt that had the potential to cause a Grexit, Nexit or Frexit. After Macron’s victory in France, coupled with improving economic conditions noted above, the spectre of further political upheaval has taken a back seat – perhaps not least because there haven’t been any notable elections in that time. However, in about a month’s time (24 September) Germany will elect its next Chancellor and government. Angela Merkel has a 15-20 point lead in the polls; online bookmakers, bwin, have Merkel 2/25 on for next Chancellor whilst closest rival Social Democrat leader Martin Schulz is at 8/1. 

Given this commanding lead, attention has already turned to what will be the composition of the coalition via which she will form a government. If the past year’s political upheaval from Brexit to Trump to Macron has taught us anything, it is to expect the unexpected when it comes to elections (and particularly polls) – or rather hedge yourself against it. Readers may recall reading extensively prior to the British general election how May would trounce Jeremy Corbyn and thereby reinforce the Tory majority. If the polls narrow to a similar extent for Merkel as we approach September 24, expect the current shine of the euro to quickly fade. This could be reinforced if Draghi and the ECB council also prove once more to be more dovish than anticipated.

 

 All views expressed here are the author’s own and are based on information available at the time of writing.

 

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