EC Always Darkest Before Dawn

To signal a multilateral spirit, Yellen may be best served by reiterating the G7 and G20 stance that markets ought to determine exchange rates, that they should move in line with fundamentals, and avoid excess volatility. It does not have to be the final word -- but as the first word, it would be reassuring.

Four G10 central banks meet in the coming days. The gamut of outcomes is likely, with the ECB ironically being the least interesting. Since it met on Dec. 10, the pandemic has gotten worse and social restrictions and lockdowns have intensified and lengthened. The uncertainty of the US election and UK-EU trade negotiations has been resolved. Key hurdles to the EU's budget and Recovery Fund were lifted.

The day before the last ECB meeting, the euro settled near $1.2080. It settled last week around $1.2150. March Brent was trading a little below $49 and rallied to almost $57.5 last week before consolidating. The 10-year German Bund yield has risen around 10 bps (to around minus 50 bps), and Italy's premium has softened from almost 120 bps before the December meeting to almost 100 bps before widening again (115 bps) amid the political challenges in Rome. There is little for the ECB to do now.

The extension of the emergency in Japan to cover the area which generates more than half of the country's output raises the downside risks. The central bank is likely to formally recognize this in one or two ways. It may shave its qualitative assessment. It could also adjust its forecasts.

In its last forecasts, issued in October, it anticipated the economy to contract 5.5% in the current fiscal year. Its previous forecast was for a 4.7% slump. The BOJ could also reduce the projection of growth for the next fiscal year, which was seen at 3.6%, up from 3.3% last July.

While peak monetary policy may generally be at hand, the Bank of Canada may be an exception. The overnight target rate sits at 25 bps. It is clear that officials do not want to adopt a negative rate, but Governor Macklem has suggested the lower bound for Canada maybe a little lower than where it is now but still above zero.

Given the economic consequences of the spreading virus and some disappointing high-frequency data, the market (overnight index swaps) has a few basis points of easing discounted. It may not exactly be clear what a small rate cut achieves, but last year the Bank of England and the Reserve Bank of Australia delivered small moves of 15 and 10 bps, respectively.

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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