We know that the Fed and the ECB are being pushed in different directions, but frankly that's about all we know ......

Wednesday 30th September 2015

  

We know that the Fed and the ECB are being pushed in different directions, but frankly that's about all we know ......

Ref : "Euro-Area Inflation Rate Turns Negative as ECB Debates Stimulus" , Bloomberg Markets

Ref : "Markets vs Economists : Who's right on Fed Interest-Rate Timing" , Bloomberg Markets

So where are we at the end of the third quarter, the worst for global stocks since 2011 ? As an increasing number of technical analysts in the US are warning that stock indices are approaching crucial chart support levels that, if broken, could open the door to much larger losses (and not just in the US), plainly these are dangerous times. But fundamentally, with particular regard to monetary policy and in the knowledge that markets hate uncertainty more than just about anything else, are we any the wiser than we were three months ago ? Sadly, the answer has to be "Not much".

In the Eurozone, the optimism engendered by a gauge of economic activity released earlier this week that pointed to an expansion of 0.4% over the quarter has been dashed by news this morning that the area has slipped back into deflation. Consumer prices in September fell 0.1% year-on-year, below the consensus estimate of zero and the first negative for six months. Unemployment remained unchanged across the Eurozone at 11.0%.

Much of the blame can of course be attributed to energy prices, but with core inflation (ex food and energy) remaining unchanged at 0.9% there's little evidence in any upward pressure on prices that the ECB so desires. Commerzbank have said that weak growth and an unemployment rate of 11.0 argues against any more than modest wage increases (and therefore price increases) in the foreseeable future. Moreover, they expect that the ECB's predictions for 2016 of growth at 1.7% and inflation of 1.1% released just this month each to be over-optimistic by 0.5%.

All of which points to the ECB having to add more stimulus by extending their current Quantitative Easing programme. 2/3 of economists in a Bloomberg survey expect this to happen, with a majority of those (which , we suppose, might only be little more than 1/3 of the total) predicting it will happen this year. Speaking yesterday however, ECB Governing Council member Ardo Hansson pointed out that whilst anything was possible, the current programme was only 6 months in to a 19 month duration and that it was too early to discuss a QE extension. All clear, then ?

Back to the States.......

Let's not go over once again the forces that argue for a rate rise in December (domestic) and those that caused the Fed to delay it (global, and dollar strength). Instead we'll just point out the vast difference in expectations between economists and the likely scenario implied by futures markets.

A Bloomberg survey of economists report that 84% expect the first rate hike to come in December. This contrasts starkly with the pricing of Fed Fund futures, which suggest only a 40% probability of a rise by year-end. This difference of "opinion" has been a recurring theme in the run-up to Fed decisions, and for what it's worth investors in futures markets have a better track record than the consensus of high-profile economists.

Should we be looking for guidance from the Fed itself ? Three senior officials, including chairwoman Janet Yellen, have said recently that they thought a hike this year was likely, but of course the same impression could have taken about the September decision before global events overtook them. Just to add to the confusion, Chicago Fed President Charles Evans said on Monday that he favoured waiting until 2016. God knows it's not easy in current circumstances, but the Fed's communication skills are bound to be called into question.

One thing however is looking more and more likely ..... previous rate-rising cycles have typically seen repeated hikes totalling 3 or 4%. This one, as and when it happens, is likely to be much less. Given the precipitous state of emerging markets and the global debt crisis, and suggestions that the US economy may be in fact nearer the end of its growth cycle than the beginning, some are suggesting that we may only see total hikes of 50 basis points, i.e. just 2 moves of 25bp each. Not what the hawks had in mind just a few short months ago .....