Investors are preparing themselves for today’s mammoth European Central Bank (ECB) decision. In a few hours the market will get to see if President Draghi again “overpromises and under-delivers” just like in December’s rate announcement or will he and his fellow policy makers up the NIRP ante?
Investors expect Draghi to deliver a monetary easing package that is worthy of driving inflation back towards its target of below, but close to +2% (current eurozone inflation sits at +0.7%). Naturally the stakes are high at todays policy meeting as no longer just a small minority of ECB governors who regard the remaining policy tools as problematic. The ECB is expected to push back against suggestions that negative rates are harmful and QE ineffective.
The tough talking is already promised; it’s the action that capital markets want to see.
1. No easy options for the ECB
Draghi will most likely deliver on significant stimulus today, though this will not be without its own complications.
Currently, the EUR (€1.0970) trades within striking distance of this week low despite traders/investors unwilling to take on big positions given the uncertainty surrounding the extent of monetary easing to be announced.
The ECB is widely expected to extend or expand its asset purchase program and cut the interest rate it pays on commercial bank deposits further into negative territory. The are two immediate problems that Euro policy makers face, first, there is a limit on the availability of bonds in the market and second, the ECB can only cut rates so much further without having unintended consequences-financial stocks would suffer.
The majority expects a -10 bps rate cut to -0.4%, the introduction of a two-tier deposit rate system, and an increase in monthly QE purchases by +€20b from March to May.
This time around it’s not what Draghi says, but what he does that will have a material impact on the EUR. A much deeper rate cut and the ‘single currency’ is expected to come under immediate pressure. Disappoint, and the EUR bulls will be feeling a tad more comfortable.
2. Reserve Bank of New Zealand (RBNZ) surprises market
Kiwi policy makers did a lot of surprise cuts, cuts that have seen the NZD (N$0.6647) plummet in the overnight session.
The RBNZ cut its cash rate to +2.25% against majority expectations of a rate hold at +2.50%. The bank also lowered its forecast for 2016 end-CPI to +1.1% (+1.6% prior), GDP to +0.7% (+0.8% prior), and 90-day bill rate to +2.2% (+2.6% prior).
In their communiqué, the RBNZ cited a litany of reasons – deteriorating global growth, weakness in China, slowdown in Europe, and expectations of longer period required to reach inflation target in New Zealand against the backdrop of higher trade-weighted exchange rate since the last decision.
Governor Wheeler remarked that the outlook implies potentially one more rate cut this year, though he also maintained that economic data could still change those projections.
The surprise cut is adding to hopes that global stimulus measures will continue to prop up markets.
3. China inflation spikes on rising food costs
Data this morning showed that China’s consumer inflation picked up in February, raising the possibility that authorities may reign in liquidity to prevent deepening inflation.
The CPI index rose +2.3%, hit its highest level since July 2014, quicker than the +1.8% increase in January. The bulk of the gains were due to a pre-holiday spike in food costs. The food components rose to +7.3% from +4.1% going into the Lunar New-Year, while non-food CPI actually slowed to +1.0% vs. +1.2% prior.
There was also increasingly more rhetoric devoted to China’s property of a “subprime”-like crisis in China’s housing market. There was talk that regulators should only incentivize activity in periphery (smaller) cities rather than primary cities where prices have already heated up.
The PBoC set the yuan mid-point at ¥6.5129 vs. ¥6.5106 prior; the second straight weaker setting.
4. Commodity Fever
Gold and silver have started off this month with a bang. Precious metals have found some momentum despite the ‘big’ dollar doing very little against the EUR (€1.0956) or JPY (¥113.43). Even February U.S jobs report has not been able to hold down metal prices.
For the first time in awhile, investors are showing a keen appetite for gold ($1,247)- it has moved more than +$100 higher since the beginning of the year and is now spreading a mild case of gold fever among investors. The ‘bulls’ believe that the yellow metal still has legs, pointing to the fact that there are willing buyers appearing on dips despite capital markets having somewhat stabilized.
5. CB knock-on-effect
Investors continue to question the efficacy of central bank stimulus at boosting growth and inflation. Policy makers can create an environment that supports growth, but they cannot actually create it.
For the past six-weeks the market has been G7 Central Bank monetary policy decision free. Being somewhat rudderless has led to very volatile moments across the various asset classes.
Over the next fortnight all the major Central Banks will be holding meetings (BoE, BoJ, SNB and FOMC) and todays ECB decision could have a massive impact on their decisions.
Investors are naturally apprehensive into policy meetings; perhaps the Bank of Japan (BoJ) could be inspired next week (March 15) at its rate decision if the ECB measures today are successful?
