ECB, Monetary Policy and Germany – My Monday column

Mario Draghi’s stance is guarded. His latest press conference gave no indication of the change in communication tone that we are set to see from the European Central Bank in January.
The ECB is finally taking on board the strength of the economic cycle and so its communication stance must adapt to this shift. This is rather good news, as the central bank constantly appeared to be acting in reaction to an environment that could swiftly deteriorate, and this shift can bolster our confidence in the strength and length of the economic cycle. The other point noted by the ECB is the move away from an exclusively inflation-based focus and towards a more broad-based communication tone. This implicitly means that the ECB is extending its reach, but really when it comes down to it, this was already the case: the ECB’s intervention has hinged on the economic cycle rather than inflation since the euro was adopted in 1999. The chart below shows the Markit composite index and the difference in the ECB main refinancing rate over 5 months, and reveals that changes in the second indicator are clearly dictated by changes in the economic cycle, rather than in inflation.

The ECB is picking up its old habits from before the 2007 crisis. Continue reading

Euro Area – Growth Momentum is still on the up side

Corporate surveys in November show that the pace of growth is still accelerating in the Euro Area. This can be seen at the global level but also in every sector, notably in the manufacturing sector where the stronger momentum is consistent with a higher international trade dynamics. Surveys also show that employment is increasing rapidly and that nominal pressures remain limited.
Continue reading

Higher bonds rates in China – Should we care?

Written with Zouhoure Bousbih

This week, the Chinese bond market has again been under selling pressure. The yield on 10-year Chinese government bonds once again flirted with the 4%, the highest in 3 years.
The Pboc (the Chinese Central Bank) intervened twice this week by injecting liquidity into the market, for a total amount of 810 billion yuan or USD 122bn , the largest injection since mid-January.
Should we worry?
No. The movement began just after the end of the C.C.P congress (end of October) when the Chinese authorities signaled clearly that they would continue their fight against high leveraged finance, ie shadow banking.
This has resulted in massive sales from Chinese government bondholders notably from  mutual funds that are the second largest holders of Chinese state bonds. They feared a tightening of financial conditions.
China’s interest rates have been low so far because of the loose Pboc’s monetary policy. The orientation has not changed but the action of the Chinese monetary policy is now more focused.
The Pboc intervened in the market by injecting liquidity in order to reduce volatility and it will continue to intervene if necessary to correct the excesses of the financial markets.
The Chinese central bank must find an equilibrium between its deleveraging campaign and the stabilization of Chinese financial markets so as not to penalize economic activity.

Does this question the attractiveness of the Chinese bond market for international investors? and the willingness of the Chinese authorities to open their bond market?
At 4%, Chinese government bonds remain attractive compared to their counterparts in developed countries,  helped by a stabilized yuan. China’s deleveraging campaign is rather a positive signal sent to international investors. China will not come back on the opening of its bond market to international investors because of the internationalization of the yuan. China’s economic activity remains sound. This is only a moment of turbulence to pass …

On the BoE monetary policy

The Bank of England has increased its main rate by 25 basis points to 0.5%.

Two reasons to explain this movement

1 – The British economy has changed and its productivity trend is much lower now than before the crisis. This means that the risk of overheating is associated with a lower growth rate than before the crisis. Therefore the BoE has to move more rapidly than in the past, the equilibrium BoE interest rate is lower.
Nevertheless, if Brexit is a source of weakness according to the BoE it is not a source of rupture (this can be discussed). The economic scenario of the BoE is quite optimistic as it suggests that productivity growth could improve converging to the momentum seen in other developed countries. Continue reading

Jerome Powell – President of the Federal Reserve

Jerome Powell nomination as President of the Federal Reserve has not created a disruption *. He was in Janet Yellen’s line on macroeconomics and on monetary policy. Nevertheless he is perceived as more market friendly on regulation than Yellen. He is perceived as someone who will maintain low interest rates and that will modify financial and banking regulation. For this he cannot be wrong in the eyes of financial investors in Wall Street. It’s also an agenda that is consistent with the White House wishes on monetary policy.

But we cannot stop here the analysis. He is not a specialist of monetary policy at a moment where the Fed is normalizing its monetary policy. The Fed is beginning an extraordinary process that consist of increasing interest rates, shrinking the size of its balance sheet and maintaining the low unemployment rate and an inflation rate close to 2%. Being able to satisfy all these objectives is and will be the most difficult task for a central banker.
It can be a terrible task for someone who is not a specialist of the monetary policy theory as Bernanke and Yellen were. Why? Because the economy has shocks positive or/and negative and that there is a need for a rapid adjustment of the monetary policy.
Until now Powell has followed the trajectory decided by Yellen. What will happen when he will have to create the trajectory? The success of the Fed depends a lot on what its president does. We know that the personality of the president of a central bank is key in the credibility of the monetary policy and in the way it is conducted. We’ve seen that in the Euro Area with the nomination of Draghi that has completely changed the picture and probably saved the Eurozone. Continue reading