The Great Divide: how markets are shaping up ahead of Fed, ECB

30 Nov 2015 | Author: | No comments yet »

ECB Draghi’s Deflation Antidote Is Beginning to Work: Analysis.

Euro-zone government bonds interrupted this month’s rally as investors questioned whether European Central Bank policy makers will boost stimulus enough to push yields lower. Securities from Germany to Portugal gave up some of their gains, after weeks of speculation of increased easing by the ECB had pushed many of the yields on the region’s two-year notes to record lows in November. Economists surveyed by Bloomberg unanimously predicted officials will increase stimulus again this week, less than halfway through the ECB’s quantitative-easing program, and most foresee multiple measures.

Market-based inflation expectations, rising since last month on base effects and seasonalities, got a further nudge up after Draghi said on Nov. 20 the ECB “will do what we must to raise inflation as quickly as possible.” Some signs that the region’s large output gap is narrowing have already emerged although it is a very long road ahead for return to full use of capacities, erasing of inventories and tightening of labor markets, in stark contrast to U.S. Even after flooding 445 billion euros ($470 billion) into the Eurosystem via public-sector debt purchases through Nov. 27, the ECB and President Mario Draghi are still struggling to stoke inflation.

Manufacturing and services PMIs have been on an encouraging upward trajectory this year, which is also borne out by pickup in European Commission services confidence. With expectations so high, “Draghi cannot beat them, but only meet them,” said Marius Daheim, a senior rates strategist at SEB AB in Frankfurt. “If the ECB includes other asset classes in its asset-purchase program, this takes some downside pressure off government bond yields.

The cost of insurance to protect against inflation going above ECB’s 2 percent target has recently edged higher, and is now above the record low hit in December 2014. Retail stocks fell after initial data from Black Friday and the first holiday shopping weekend showed shoppers were not going to stores as much as last year. The latest two-year sovereign yield to tumble to a record was the Dutch, touching minus 0.401 percent on Monday, the least since Bloomberg began collecting the data in 1994.

Reports from research firms like ChannelAdvisor showed strong growth in sales online. “We believe Black Friday has gone from a period of management excitement to one of anguish,” Nomura retail analysts Simeon Siegel, Gene Vladimirov and Julie Kim wrote in a note to investors. The 13.7 billion euros of government debt bought in the week to Nov. 27 under the ECB’s program was the largest amount since the second week of QE in March.

Markets may need to see actual realized inflation before generating a convincing upward trend, given Japan’s unsuccessful attempts to revive inflation. Realized inflation will likely get a leg up over the next few mos. due to base effect from the steep declines of oil in fourth quarter of 2014, but that should be no surprise. Third-quarter ECB Survey of Professional Forecasters shows inflation will reach 1.5 percent in two years, compared with 1.2 percent estimated in March. ECB QE restrictions currently prevent the central bank from buying any security yielding less than the deposit rate, which currently is minus 0.2 percent, so a reduction would bolster the number of bonds eligible for purchase.

A 10 basis-point cut to minus 0.3 percent is fully priced in, according to futures data compiled by Bloomberg, while the lowest forecast in a Bloomberg survey was for a reduction to minus 0.45 percent. IN CONTRAST: While the ECB moves toward increasing stimulus, the Federal Reserve is getting ready to start raising interest rates for the first time since June 2006. A series of U.S. economic reports this week, culminating with Friday’s jobs survey for November, could cement investors’ expectations for a rate hike at the Fed’s next policy meeting in mid-December.

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