Thursday, May 8, 2014
A lot of central bank headlines today, with interest rate
decisions by the European Central Bank and the Bank of England and
another day of congressional testimony by Fed Chairwoman Janet
Yellen. The ongoing sell-off in the momentum stocks will likely
continue with softer looking reports from
) adding to what we saw from
) the other day.
The European Central Bank's (ECB) interest rate decision this
morning didn't surprise anyone, though the markets do expect the
central bank to start its own version of a QE program in the
not-too-distant future. The persistent disinflationary trend in the
region, which seems to be getting support from the common
currency's strength, lies at the root of these QE hopes.
Many are hoping the ECB will start the program at its June
meeting, and will be looking for clues in Mario Draghi's press
conference today. Thus far, the bank has been mostly talk and not
much action, which isn't that different from the currency union's
The policy outlook for the Euro-zone runs counter to what is
expected in the U.S. where the Fed is on track to get out of the QE
program by the end of the year. In her Congressional testimony on
Wednesday, Yellen showed plenty of confidence in the U.S. economic
outlook for the current and coming quarters. This view is broadly
in-line with the stock market consensus, which is looking for U.S.
economic growth to 'graduate' to an above-trend pace in excess of
+3% this year and beyond.
The Fed's policy is to move away from relying solely on direct
bond purchases as a means to influence long-term interest rates and
use instead forward guidance to anchor market expectations. This
seems to be working just fine, as long-term yields have come down
despite continued QE Taper and growing signs of a rebound in the
economy following Q1's flat finish.
All of this seems plausible enough. But the counter argument is
that the recent downtrend in treasury yields has nothing to do with
effectiveness of the Fed's policy or even a safe-haven trade
resulting from the Ukraine situation - it is actually a reflection
of the bond market's skepticism about the Fed and stock market's
economic outlook. In other words, the bond market simply doesn't
see the U.S. economic growth picture improving so materially from
its recent path and is betting those optimistic growth estimates
will come down going forward.
Hard to tell which view is 'on the money' at this stage. The
debate will likely go on for some time, but if I had to take sides,
I will go with the typically more rational and unsentimental bond
market. The current tentativeness in the stock market is a
reflection of this debate.
Director of Research
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