Have Central Banks Lost Credibility?

After the announcement, speculation began how quickly the European Central Bank will follow the Federal Reserve and begins to raise interest rates. We were quite surprised because every reasonable analyst seeing the economic slowdown in the Eurozone and the dramatic situation of the banking sector knew that the ECB would soon return to the loose monetary policy rather than to the increase of the interest rates. In regards to this, we have written this article "Does the ECB really end up printing?" https://independenttrader.org/did-the-ecb-really-end-up-printing.html suggesting that the European Central Bank may soon consider another program of cheap loans available to enterprises (the so-called TLTRO).

What do we know after a few weeks of 2019? First of all, we can forget about the increase of interest rates. The market assumes that the first hike will take place in 2020, but we think that the interest rates will move in the opposite direction, despite the fact that they are already on zero level.

Low-interest loans for companies have been already discussed at the ECB meetings. It is assumed that Mario Draghi will talk about this issue in March and the loans will be made available in June. We think that it is a feasible scenario - the slowing Eurozone economy will certainly put pressure on the ECB to support the economy (regardless of whether the support works or not).

Moreover, considering the fact that the ECB supposed to finish the assets purchases in December, as a result, the bank's balance sheet should stabilize. However, in January we observed that it was still growing (green dotted line on the chart), which makes the ECB credibility becoming similar to this of the Bank of Japan.


Indecisive Fed

Just over four months ago, the sentiment on the American stock exchange was outstanding. Most investors were convinced that if somebody wants to invest, should do it in the US. Moreover, the Fed chairman Jerome Powell firmly argued that he intends to continue raising interest rates and reducing the balance sheet and only the bad economic situation may change his attitude.

Three months of decreasing stock prices were sufficient to change the environment dramatically. Currently, the market is pricing a rate cut more than the rate hike in 2019, and the Fed itself capitulated saying that the end of the balance sheet reduction is possible. It is once again a confirmation that the central bankers pay a lot of attention to the quotations on the financial markets.

What's next?

It looks like central banks are making great efforts to maintain good mood among investors. Unfortunately, this is not enough. Chinese economy is slowing down and the stock exchange is not performing well despite the loose monetary policy of the Bank of China. In Europe, we can officially say that the recession has come to Germany and Italy, and more countries are waiting in the line. It is true that the economic situation affects the markets, so the banks' stock prices are poor and corporate bonds are in a bad place. It is not even worth to mention Japan. Only the United States remain relatively solid, where the stock exchanges and the economy have both better and worse moments. On that basis can we say that if you want to invest, you should do it in the US?

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Moon Kil Woong 1 year ago Contributor's comment

Sadly Japan is in a QE hole they can pretty much never get out of without a serious collapse in their economy. Their economy is dependent on the funny liquidity and their markets are increasingly driven by it and the government. This is why their economy doesn't ever recover. Their people's future is not in their own hands thus it is hard for businesses to bet on what they can't control. Thus understandable no one wants to invest in growth.