Despite the onset of the festive season, the European Central Bank (ECB) did not give the financial markets the warm feeling for which they had hoped. Stock and bond prices plummeted as a result and the euro gained some ground.
Encouraging news emerged from the eurozone last week about business and consumer confidence
Ben Steinebach Head of Investment Strategy
It initially appeared inevitable that the ECB would up the intensity of its stimulus policy – particularly following the news on Wednesday that the rise in consumer prices in the eurozone had stabilized at the low rate of 0.1% in November. In fact, disregarding food and energy prices, inflation dropped from 1.1% in October to 0.9% in November. Despite these developments the ECB did less than expected. The deposit facility interest was further cut from -0.2% to -0.3%, whereas the markets had counted on -0.4% – and then perhaps only on major deposits placed with the ECB. The bond buy-back programme will be extended until March 2017, yet the ECB will not raise the monthly volume by 10-20 billion euros, as predicted, on top of the current 60 billion euros. The increasing scarcity of suitable bonds also means that the Bank might need to start buying more types of bonds, including regional bonds (issued by Germany’s federal states, for example). Essentially, the markets had hoped that the ECB would announce that the programme would remain in place indefinitely and that the refinancing interest (at present 0.05%) would be lowered.
The European stock markets, already quite nervous, lost around 3.5%, while the euro recovered some of its value against the US dollar. Nevertheless, the US stock markets were also hit by considerable losses (around 1.5%). Bond markets around the world also fell, with bond yields climbing 10 basis points in the United States and in Europe’s core countries, while the increase along the periphery of Europe was around twice that. Presumably the opponents of the cheap-money policy that Mario Draghi favours have gained greater sway within the ECB’s Executive Board. They consider that policy to be less effective than its supporters do, particularly over an extended period of time. They are also concerned that it will cause bubbles on the financial markets.
Impact of the ECB’s policy, within the eurozone and beyond
The response on the US markets to the ECB's decision was perhaps triggered by the increased likelihood, now, of an imminent US rate hike: a more aggressive course of action by the ECB and a stronger dollar would have rendered it less pressing for the Federal Reserve (Fed) to raise its own interest rates. Now, however, it appears inevitable that the meeting on 15-16 December will end with a rate hike, as Fed Chair Yellen has suggested in recent speeches. The US economy is strong – strong enough, at least – and she believes that delaying an initial rate hike too long would necessitate greater subsequent increases. As matters stand we expect the pace of the increases to be very gradual, putting interest rates at 1.25% – still low – by the end of 2016 (with rates currently standing at 0%-0.25%). Other countries will also be impacted by the ECB’s policy, for example Sweden and Switzerland, two countries that still have their own currency. The move by the ECB has diminished the latitude for central banks in both these countries, whose currencies are feeling some pressure relative to the euro, to ease their own policies.
Encouraging macro data fail to buoy the stock markets
Last week’s macroeconomic news – both in Europe and in the United States – was fairly positive. The stock markets remained downbeat, though, despite the lack of much corporate news. On Monday the IMF announced that the Chinese yuan will be included – on 16 October 2016, at a weighting of almost 11% – in the SDR, the IMF’s notional currency that is used primarily by central banks. China has implemented sufficient reforms to justify this inclusion. The currency is gradually becoming more freely tradable and the Chinese bond markets are being thrown open to non-residents. Nevertheless, we believe that investors will remain cautious for the present, as the country cannot yet be termed a ‘safe haven’ in the same manner as the dollar’s territory or the eurozone.
Encouraging news emerged from the eurozone last week about business and consumer confidence: in November the Economic Sentiment Index – which combines both these indicators – climbed to its highest point in four years. Despite a slight decline in retail sales in October, factoring in online sales shows that spending is in fact moving upward. The sentiment among purchasing managers in industry fell slightly, while the sentiment in the service sector remains very positive. That same optimism is visible in the United States, where the job market also continued its upward trend. One of the highlights in the week’s corporate news concerned German giant RWE’s decision to transfer its sustainable energy division to a new company. This follows a similar move by E.ON, which had previously spun off these promising operations. In the Netherlands new reports about Delta Lloyd emerged: the insurer has announced a series of measures to strengthen its capital position and ensure compliance with the new requirements imposed by the regulatory authorities (Solvency II). The AEX tumbled (mostly on Thursday) 4.7% relative to the Friday before to 449.92 points, registering one of the largest drops in Europe. By Friday morning the index had recorded a further loss and was down to 446-447 points.
Slow week for news
This week’s agenda is largely empty. Corporate news will be scarce, and little news is anticipated in the macroeconomic arena too – unless something unexpected happens of course. Two important events were scheduled for Friday: first the meeting of OPEC, which was thought to result in measures to boost the low oil prices and relieve some of the pressure, and second, at 2.30pm, the publication of the US jobs report for November. This was naturally highly anticipated, being the final test before the Fed decides on its interest rates in a fortnight’s time.
This week will see some data about the leading indicators in the OECD and in Japan. Germany will publish details about the cost of labour, which have bearing on future inflation in the eurozone’s largest economy and therefore also on the ECB’s policy. The European Union and Japan will publish second estimates (including breakdowns by expenditure categories) of their Gross Domestic Products. Information about inflation is expected from China, France, the Netherlands, Germany and the United Kingdom. The UK, Italy and the Netherlands will announce data about industrial output. In the United States an initial estimate of consumer confidence (as measured by the University of Michigan) will be presented. Lastly, the central banks of both the United Kingdom and Switzerland are scheduled to meet to discuss their own interest rates – this will be interesting against the backdrop of the surprise sprung by the ECB last week.