No political upheavals today (so far) .....

Wednesday 7th December 2016

No political upheavals today (so far) ..... time to return to a spot of Central Bank watching.

ref:- General

It's not as though the issues of Italy, Brexit and President Elect Trump have sorted themselves out in any way, but in the absence of any erupting news stories the market has turned its attention back to where it rested for so long ..... central banks and their monetary policies.

As we said the other day, it's just about certain that the US Federal Reserve will raise rates by 25 basis points on Dec 14th  --  the main point of interest in that announcement is likely to be what hints Chair Janet Yellen gives with regard to the pace of future rate hikes. Of greater and more immediate interest right now is what the European Central Bank (ECB) will do tomorrow.

Don't expect any rate changes ..... focus will be on what the ECB does with its Quantitative Easing Programme, which is currently purchasing bonds at a rate of 80 billion euros per month and theorectically is due to finish in March. Frankly, most believe that QE will be rolled out beyond that point, the question is "by how long?" and "in what size?". The options in play seem to be to extend the programme by either 6 or 9 months and at a rate of between 60 billion or 80 billion euros per month, with any combination of those numbers possible.

The hawks in the ECB and in the wider Eurozone, especially Germany and like-minded northern European neighbours, will have to suffer the ECB's ultra-easy monetary policy (though not necessarily in silence). In fact ECB boss Mario Draghi, who on balance is thought to favour a doveish approach, may see a silver lining in recent political storm clouds in that they argue against this being a good time to start turning off the taps despite markets reactions to Brexit and Italy being relatively calm. Mr Draghi also has some uncomfortable experience of how even the suggestion of "tapering off" QE bond purchases can rout bond markets that have become used to unprecedented levels of central bank support. The increase in borrowing costs brought on by rising bond yields / falling bond prices could stifle the economic growth that is only just now visible in large parts of the Eurozone.

One could ask when exactly would be a good time? The ECB can't keep adding to its balance sheet forever ..... True enough, but the ECB would probably point out yet again that its mandate is to act for the wider Eurozone, much of which still needs the help of its ultra-loose policies. In other words, the time is not yet right.

Then again, they might not ..... but on balance, the median consensus seems to be for an extension for 6 months at an unchanged pace of 80 billion euros per month. More hawkish should see the Euro continue its bounce and bond yields higher, more doveish and the opposite might be expected. At least that's the theory, but as we've all seen on numerous occasions recently, impeccable theoretical logic is not always being backed up the expected market moves. Well, that would be too easy .....

ADDENDUM: Assuming for a second that the ECB does go with that consensus number above ..... that's another 480 billion euros of bonds that they'll be buying. The market will be keen to know where exactly they're going to find them  --  there's already a growing shortage of suitable German Bunds, for example. The so-called "capital key" dictates that the amount of each nation's bonds purchased by the ECB is determined by the size of that nation's GDP ...... for example, Germany has the largest GDP so the ECB must buy more German Bunds than anything else  --  it's a percentage thing. Which is not ideal since there may be less of them than some others due to a healthy budget surplus and Germany doesn't need the stimulus. They could abandon the capital key but that would be politically difficult as it effectively requires stronger nations to support weaker ones. They could allow purchases of bonds with yields below the ECB's discount rate of -0.4%, but that guarantees substantial losses if held to maturity. They could allow purchases of more than 33% of one issue but that is dangerous for market liquidity. The list goes on. The ECB has some tricky decisions to make ..... we're holding our breath already.