Five years ago, global markets went into hysterics at the mere hint that the Fed might taper its quantitative easing program – an event commonly known as the ‘taper-tantrum’. Bond yields increased sharply at any prospect of ‘normalising’ the artificially low monetary policy environment to which the markets had become accustomed. While it would be some time before the Fed would have the confidence to enact such policies, the event was significant in as much that real yields in the US went from negative to positive, and have remained there ever since.
Comments from two ECB officials last week have raised the possibility of a European taper-tantrum as the market responded with a sharp rise in government debt yields. The snap response from the markets to these vague remarks suggests any attempt at ‘normalising’ ECB monetary policy could be premature. The markets’ concerns are not unfounded, with the ECB having a track record of premature policy blunders. Notable examples include raising interest rates in 2008 when global banking institutions were on the cusp of collapsing; enacting two rate increases in 2011 as the sovereign debt crisis was escalating; and more recently, in 2013, when the ECB set about shrinking its balance sheet just as Eurozone was thrown into a deflationary panic. All three of these events were followed by drastic and almost immediate reversals. Arguably, the lack of confidence these events have instilled in the markets has contributed to the need for the more recent aggressive expansion of the bank’s balance sheet.
Furthermore, there is minimal empirical evidence to warrant the reversal of current policy, with recent growth data being less than impressive and core inflation, which strips out short-term influences, showing little signs of climbing much above the recent average of 1.00% - a level significantly below the 2.00% target. This comes despite the headline CPI figure rising to 1.9% as oil prices increase and the euro depreciates against the dollar, although neither are seen as being long term concerns.
Despite this, the ECB will announce on Thursday that they will be ending their asset purchasing program by the end of this year – a prerequisite to any attempts at raising interest rates. In doing so, the ECB will be sending a signal to the market that it remains confident in the long-term economic fundamentals and intends to look through short-term distortions including geopolitical risk and disappointing Q1 growth figures – the latter potentially being a blip owing to strikes and poor weather. Data out last week goes some way to supporting the bank’s view with consumer spending for Q1 and April retail sales increasing. Furthermore, increasing consumer confidence would appear to have a solid foundation as annual growth in wages rose to 1.9% for Q1, a five year high, suggesting a tightening labour market is creating a modest amount of inflationary pressure. Employment data out on Wednesday and labour costs on Friday are expected to further support this view.
Whether the ECB’s announcement is simply an early signal to the markets or a promise of more imminent policy action, it is certainly a statement of confidence. This will be timely as Eurozone leaders continue to negotiate with a US administration hell-bent on imposing trade tariffs under the guise of protecting its national security interests– something that has clearly riled longstanding allies including Canada, which looks set to follow the EU in introducing retaliatory action targeted directly at the Presidents core support base. While a full-blown trade war remains unlikely given that it would be in the long term interest of no-one (including the US who have been witnessing an impressive annual export growth of 7.5%) the risk has certainly gone up a notch. This weekend’s G7 conference only served to deepen US isolation on key policies of trade, Iran and the environment – a far from ideal position for Brexit-bound Britain desperately hoping to secure favourable free-trade terms.
A similar signal of confidence from the Bank of England remains in the balance for August, with the markets pricing in a 60% chance of a rate increase following signs of improving economic growth. Last week’s PMI numbers implied Q2 growth figures of c. 0.4%, up from the weather subdued 0.1% in Q1. Thursday’s retail sales figures for May, which are expected to be 0.1% following April’s extremely impressive 1.6%, may even support higher growth estimates owing to a consumer confidence revival. Labour figures on Tuesday would support the notion that there are robust foundations to consumer confidence with employment continuing to grow and average earning growth of 2.9%, representing a continuation of real wage growth with Wednesdays CPI figures for May holding steady at 2.4% as recent oil prices prevent any fall.
In the US the Fed will almost certainly undertake a further rate increase on Wednesday. This will come as Tuesday’s inflation figures for May show consumer prices reaching a 15 month high of 2.6% from 2.5% in the previous month with core prices at 2.2%. There will be a similar trend on Wednesday with producer prices data.