Slower for longer ? This ECB tapering look like it's going to take a while .....

Thursday 19th October 2017


Slower for longer ? This ECB tapering look like it's going to take a while .....

ref :- " ECB eyes slow stimulus taper to keep lid on euro" , The Financial Times

We were only saying on Monday that plainly a good many players were viewing the slight pullback in EUR / USD from it's highs just above $1.20 set last month as little more than a breather in the uptrend rather than a reversal. With EUR / USD trading today at $1.1835 near the top of its recent range, the euro is giving the impression of wanting another go on the upside despite some factors that one might normally expect to undermine the common currency.

Foremost among them is the Spain / Catalonia affair which FX traders seem happy to ignore for the time being even though for some of us it's hard to see a happy conclusion to the issue. Perhaps even more surprisingly, traders are taking little notice of the monetary policy plans of the two relevant central banks being further apart than some imagined, and the growing dollar-supportive interest rate differential that would seem to be the likely result.

We know that the US Fed is embarked on a course that they expect will take interest rates to 2.0% by the end of 2018, and that they are starting the long process of reducing the balance sheet swollen by $4.2 trn of bond purchases accumulated through the QE process  --  quantitative tightening, in other words. By contrast, the ECB's main refinancing rate is 0% , and its deposit rate minus 0.4%  --  record low levels that the bank has promised to maintain "well past the horizon" of QE in order to nurture the region's recovery. Doesn't sound like an obvious reason to buy euros, does it ?

The thing with the future directions of markets though is that they're not really about what we already know  -- that's already in the price. It's more about perceptions of what will happen in the future. The tightening going on in the States has been going on for some time and future moves have been well-signposted  --  it's already in the market, as they say. One of the prime factors behind the euro's rise of late has been the contemplation that , sooner or later , the ECB will rein back its QE bond-buying programme (i.e. start to taper) and eventually begin its own task of balance sheet reduction. The fly in the ointment for euro bulls may be that the process may take a bit longer than expected.

This time next week we'll hear from Mario Draghi as to the ECB's plans for future asset purchases. The prevailing wisdom until recently was that come the start of 2018, the current €60 per month of purchases would be reduced down to €40 per month, and finish entirely as early as June. No longer ..... all the recent hints from ECB bigwigs (from both sides of the argument) point to a slower tapering process, and that QE could still continue until December 2018.

Assuming the total amount of asset purchases remains the same, if they double the remaining period of QE (to 12 months) then we can expect them to halve the amount per month (to €20bn). But if the total amount does remain the same, what's the point behind a slower for longer policy ?

Stronger rate guidance

As we've said, the ECB will not consider raising rates until QE is finished. The more gradual approach will push rate rises into 2019 at the earliest. Once the plans of BOTH central banks are known, the way would be clear for the market to re-focus on interest rate differentials and at least put a lid on EUR / USD. There's no doubt that the strength of the euro this year, and its deflationary effects, has been a big factor in the argument for a more gradual end to QE.

Address scarcity

One of the big potential problems with such a vast QE programme couldn't be more fundamental  --  the lack of enough suitable bonds to buy. In effect, the size of purchases of each nation's debt must mirror its economic strength. So German Bunds for example must make up the largest individual portfolio of purchases  --  which is about to be a problem because Germany does not run big deficits and at the current rate there won't be enough Bunds out there. But the limitations on what the ECB can buy become looser the longer the programme goes on for, and the slower the rate of purchases, with more debt becoming available over time.

Avoiding tantrums

A slower taper, it is argued, will still achieve what the ECB wants it achieve whilst at the same time giving the markets more time to prepare for the day that bond purchases cease entirely. How much time do they need, for goodness sake ? A fair question, but history suggests the more the better, and the knowledge that interest rate hikes are on hold for longer should also keep things calm. You may or may not think that the markets must be a bit precious, but one can understand how the slower for longer plan might appeal to the ECB rather than cutting from €40bn per month to zero after June.

There are two assumptions being made here, we reckon. Firstly, that the ECB will announce exactly what the market thinks it will announce next week .... we'll bow to the superior knowledge of others on that one. And secondly, that market reactions to the ECB plans will be roughly as they envisage.

Markets being markets, that's altogether much less certain.