Central Banks: Easing in the Air

Mid Week Bond Update

Central Banks: Easing in the Air

Are the Fed and the European Central Bank leading the charge for lower benchmark rates?


The European Central Bank (ECB) briefly stole the spotlight the day before the Fed’s June 19th rate decision by making explicit its willingness to drive its benchmark deposit rate, now ‑0.40%, even further into negative territory, if needed to boost the Eurozone’s flagging economies.  ECB Chairman Draghi also invoked the potential to restart its previously-completed asset-buying program.

In doing so, the ECB joined the Fed in taking a more dovish stance. Recent statements by Chair Powell are widely expected to presage a series of rate cuts beyond the FOMC’s decision on June 19th.  For the Fed, the rationale includes the persistence of below-target U.S. inflation despite a record-low headline unemployment rate, and the continuing trade disputes with China, the European Union (EU), Canada and Mexico.

Financial markets appear to believe that inflation will head even lower; the 5-year / 5-year inflation breakeven rate stands1 at 1.50%, reflecting expectations embedded in the market for 5-year Treasuries and their inflation-adjusted equivalents; Western Asset’s John Bellows observes that the market might be ahead of itself, but that the direction of rates shown in the market looks right.

 

U.S. Inflation and Rates: New Economic Realities?

Chart depicting inflation rates

Source: Bloomberg, as of 6/17/2019.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
 

On the rise: European sovereign debt

ECB President Draghi added to the list of moves earning him the nickname “Super Mario”,  clearly stating that further lowering interest rates was the Bank’s “weapon of choice” in fighting economic torpor.

In doing so, he changed the market consensus about what will come after his eventful 10-year term as President, which ends on October 31, 2019.  Markets in Europe and elsewhere took him at his word, driving yields downward.  Germany’s 2-year sovereign bond yield fell ‑7.0 bps, at one point reaching as low as -0.766% – over five standard deviations from its 90-day price band. Even Italy’s 30-year sovereign bond joined in, falling -14.9 bps to 3.144%, just over 3 standard deviations.

Though it’s unclear what the future holds for the ECB as Draghi hands over the reins, it should be noted that Draghi’s dramatic statement, made at an annual meeting of ECB members and staff, is unlikely to have strayed greatly from the consensus of the ECB members who will continue on after his departure.

On the slide: The euro

In the world of forex, one currency’s gain is another one’s loss.  And so it was with the dollar and the euro on June 18th, when the euro fell 6 basis points against the greenback as ECB President Mario Draghi made his policy speech about reducing rates yet again at the Bank’s annual conference in Sintra, Portugal. The euro’s short-term move was reasonable from the point of view of relative interest rates, as was the fall in the yields of Bunds, whose10-year yield rose over 7 basis points to -0.322%, a record low yield.

On the flip side, the dollar rose about five basis points against the euro. But the spot rate for the trade-weighted dollar rose 0.41% on the same news, bringing its 5-day rise to 1.21%.

 

 


1 Source: Bloomberg, June 18th, 11:10 AM ET

All data Source: Bloomberg, June 18, 2019 unless otherwise indicated.

 

Definitions

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Personal Consumption Expenditures (PCE) Price Index is a measure of price changes in consumer goods and services; the measure includes data pertaining to durables, non-durables and services. This index takes consumers' changing consumption due to prices into account, whereas the Consumer Price Index uses a fixed basket of goods with weightings that do not change over time. Core PCE excludes food & energy prices.

The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

Forex is a shorthand term, referring to foreign exchange or currencies.

The 5-year, 5-year forward breakeven inflation rate is a measure of expected inflation derived from "nominal" Treasury securities and their "real" counterparts—inflation-protected TIPS securities.

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System (Fed) responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Bunds” refers to bonds issued by Germany's federal government. Bunds are available in 10- and 30-year maturities.

One basis point (bps) equals one one-hundredth of one percentage point.

 

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