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He Said, He Said…A Tale of Two Central Banks
By: Martin Tillier
He Said, He Said…A Tale of Two Central Banks
When Central Bankers’ tongues wag, the rest of us listen. We parse their every statement, looking for clues that only we can see that will give us an edge as traders. We expend much ink and many electrons discussing the possible implications of every phrase they use. Markets react to the slightest change in the vocabulary or syntax of any statement. They know this of course, and attempt to use it to their advantage. We have two examples of this in the world right now. Both the ECB and the Federal Reserve are trying to use statements to influence markets in place of, or in front of, policy changes, with different results.
I recently wrote elsewhere about the ECB’s latest mutterings. Last week various European Central Bank officials gave speeches that seemed to indicate that an accommodative monetary policy is here to stay in Europe. There is a lot at stake here. If markets believe them, there will be two beneficial results.
Firstly, it will ease the pressure on the sovereign bonds of those nations that have been under pressure, the so called PIIGS, even further. 10 Year Government bonds in, say Italy and Greece, are off of the high yields from the end of 2012, but over 10% in Greece and around 4.5% in Italy is hardly cheap borrowing compared to the rest of the developed world. The second effect would be a further weakening of the Euro, something which would serve to boost exports and help speed up the recovery.
The problem is, I don’t believe them. The ECB has, since its inception, acquired the reputation of being all bark and no bite; at least in the Forex market. There is an inherent difficulty in getting the representatives of so many diverse nations to agree on monetary policy. Look at the run-up to the problems of 18 months ago. It was obvious to most observers that some sort of easing of monetary policy was needed. The Germans, however, with their historically understandable fear of inflation, blocked any such attempt until it was almost too late. There is little chance that they will allow it to continue indefinitely.
This inability to act quickly is nothing new. It has led to a tradition of ECB officials attempting to influence markets by what they say, rather than what they do. After a few times when no action followed the talk, many, myself included, began to see ECB efforts to influence the market as great contra-indicators. Their attempts to talk the markets up or down would fail, but the chances are that the underlying trend they feared would come about. Taking the opposite of the position they wanted you to was usually a decent strategy. This led me to conclude that the ECB’s recent attempts to talk the Euro lower will signal a period of Euro strength and my medium-term outlook for Euro Dollar has shifted to bullish.
The position with the Federal Reserve is somewhat different. They did act quickly during the recession, adopting a near zero interest rate policy and starting the bond buying program known as QE to inject capital into the financial system. Whatever you think of their actions, they were at least timely and decisive. The problem they have is how to get out of the program with minimum disruption. By talking about the now famous “tapering” extensively before it becomes reality, it would seem that they have managed to get the markets somewhat used to the idea.
When talk began back in May the market reacted negatively, and again last month when the FOMC minutes were released. Then, last week, the most recent minutes were released, showing that nearly half of the committee’s members wanted tapering to start immediately. The stock market, starting from higher levels than in June, continued on higher.
It would seem that those of us who said back in June that that move was a buying opportunity were correct. In this case, unlike with the ECB, it would seem that the verbiage is doing its job. Traders are used to trusting the Fed’s reading of the economy and know that if things deteriorate the stimulus will continue. It is making the prospect of a gradual end to QE less scary to the market, thereby increasing the chance of an orderly exit.
The point is that not all Central Bank chatter is the same. Some, like the ECB’s has been shown over time to be completely ineffective and disrupt the markets, making it worth betting against them. Some, like the Fed’s, serves to minimize disruption, and it is usually beneficial to do what the Chairman would like you to do. If you are to trade or invest successfully you must listen to it all. How you react, however, depends more on who said it than what was said.