Is it, or is it not, the first move towards tapering?

Friday 9th December 2016

  

Is it, or is it not, the first move towards tapering? Nobody seems quite sure, and that will suit Mr Draghi just fine ..... for now.

ref:- "ECB to cut monthly bond buying ....." The Financial Times, Lead Story, and "Not a taper....", Editorial and Markets

On Wednesday we noted that on balance the most commonly held forecast of what the ECB was likely to do at its meeting yesterday was to extend the QE bond-purchasing programme for a further 6 months from March, at the unchanged rate of 80 bln euros per month. In the event, they extended the programme for 9 months at the lower rate of 60 bln euros per month. Ah yes, it's always good to have the finger on the pulse .....

Actually, the market as a whole was a bit confused about what to make of things. Initial focus was on the reduction in the amount of bonds to be bought, and whether that reflected the first sign of the ECB slowing its monetary stimulus. Cue bond prices down / bond yields up and a rally in the euro to $1.0872. But as soon as ECB boss Mario Draghi had made it plain that the idea of "tapering" bond purchases had not even been discussed and that the ECB would remain "active" in uncertain times, things reversed themselves pretty quickly  --  EUR / USD back down to $1.0610.

How Mr Draghi must hate that word "tapering", with all its connotations of market crashes. Ben Bernanke, then Chair of the Fed who coined the term back in 2013 with reference to winding down the Fed's own QE programme, must have thought that it summed up the intended process rather neatly ..... that is until he saw bond markets collapsing all around him. Obviously Mr Draghi, who is naturally on the doveish side of the argument anyway, would want to steer well clear of the word and of anything else that could be interpreted as monetary tightening in such uncertain times.

He has support on the ECB board, largely from the southern Eurozone nations who were pushing for a 12 month extension (basically irrelevant  --  if the ECB feel they need to extend again, they will). He might also point out that the ECB's inflation forecasts of just 1.7% through 2019 (against a target of 2.0%) hardly argue for any tightening of the reins.

But there is huge pressure within both the ECB and the Eurozone generally to scale back bond purchases. The Germans for example voted against yesterday's move on the grounds that such ultra-easy monetary policy punishes savers and pension holders, damages the banking system and allows Europe's peripheral, weaker nations to postpone vital economic reforms. In addition and most importantly, this is all taking place against a global backdrop in which the idea that endless monetary easing has run its course is gaining momentum.

So Mr Draghi has a very precarious path to tread with competing arguments strongly held even on his own board. For now, the anxiety about what tapering QE might mean for borrowing costs in those vulnerable member states (Portugal? Italy?) and political storm clouds are winning the argument .... just about. Those factors and the very gentle pace of recovery, of course. You could say that to extend QE by nine (rather than six) months is a neat measure that  postpones the next awkward decision until after crucial German elections, and that everything else is open to interpretation despite Mr Draghi's soothing words. He might settle for that .... though it does little to dispel the impression that the differing requirements of factions within the Eurozone will come to a head at some point.

Another weekend in Vienna?

Be aware that OPEC is hosting a meeting tomorrow with non-OPEC oil producers to nail down their commitment to a 600,000 bpd cut in output to go alongside OPEC's new agreement. Russia, assuming its most responsible mantle, is said to be ready to fulfill its promise to cut by 300,000 but wants details on how compliance with production quotas will be monitored. Good idea, though it does bring pots and kettles to mind .....

The issue of non-OPEC production has been putting a cap on the market over the last couple of days, and an agreed deal would probably signal further gains. Of course, around $55 per barrel for WTI is the level where many believe the US shale oil producers will be back in business in a big way. The flatness of the futures curve after mid-2017 suggests that they've already been hedging future production at current levels. All things being equal, futures prices would normally be expected to climb the further forward you go due to the costs involved in financing, storage, insurance etc. Will the shale guys provide the next lid on oil prices?