ECB Fiddles As Eurozone Turns

Compared to US Fed, ECB seems flat-footed as growth slows

During the recent period of market volatility, the US Fed has in our view successfully re-positioned itself on the doveish end of expectations, both in terms of interest rate and more recently balance sheet policy. The ECB in comparison appears flat-footed, with ECB President Draghi failing to use the opportunity in his press conference last week to emphasize policy flexibility in the event of a downturn. Ironically, the most recent disappointing incoming data is concentrated in the eurozone, rather than the US.

That the US Fed is reportedly (WSJ 25/01/19) considering ending its balance sheet reduction program much earlier than previously anticipated is a remarkable turnaround given Fed Chair Powell’s comments as recently as December that quantitative tightening (QT) was on “autopilot”. Policymakers do not seem to have an especially clear idea of the impact of any reduction in the pace of QT, but may have been spooked by the rapid declines in certain segments of the credit markets during the course of Q4. In particular, leveraged loans and high yield bonds suffered significant losses. In the case of high yield bonds, the new issue market briefly shut completely.

By allowing 2019 US rate expectations to fall and also raising expectations of a change to balance sheet policy, the US Fed has clearly reacted to the volatility in capital markets. Since the Fed changed tack, leveraged loan and high yield bond yields have quickly recovered, despite a number of alarm bells rung by well-respected organizations on the excessive growth and declining quality of corporate credit.

Yet as originally noted by the US Fed, incoming economic data for the US has been largely in-line with expectations in recent months. It is in the eurozone where activity appears to be suffering from a sharper softening.

Draghi’s wait-and-see theme during his press conference last week was not unexpected; absent an emergency it is probably easier to move ECB Governing Council opinion on the basis of the next set of economic projections, due in March. Draghi also confirmed there was consensus on the cause of the eurozone slowdown – uncertainty in respect of Brexit and trade, declining China growth, a fading US fiscal stimulus and the specific auto industry issues.

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