Fed vs. ECB: Dovishly DIfferent

Mid Week Bond Update

Fed vs. ECB: Dovishly DIfferent

The two central banks have similar objectives, but are working to solve different challenges.


The back-to-back press conferences by the Federal Reserve (Fed) on December 11 and the European Central Bank (ECB) on December 12 offered welcome messages of policy continuity, each with its own mildly dovish tone.  

But over and above the Fed's message that its current stance is "appropriate", Chair Powell's post-decision press conference hinted at progress in the FOMC's ongoing "framework review" of how its inflation targets are determined, as well as how they might be met. 

In addition, as Western Asset's John Bellows observed, Powell's Q&A session clearly conveyed his continued determination to meet a stubbornly elusive 2% inflation target.


Fed and ECB Policy Rates, December 2013 - December 2019

Source: Bloomberg, as of 12/17/2019. 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.

 

The ECB's declaration of policy continuity differed from the Fed's largely in terms of context. The December 12 post-decision press conference was the first conducted by incoming ECB President Christine Lagarde, heightening the focus on possible deviations from her predecessor's messaging.  As observed by Western Asset, the press conference was a success from that point of view, with little perceptible divergence from previous policy stances.

Second, Europe's economy is in notably worse shape than is the U.S., making the interest in aggressive accommodation all the greater -- despite the belief by many policymakers that monetary remedies have run their course, with  fiscal stimulus offering greater impact.
 

On the rise: Mexico Minimum Wage

Mexico's Labor Minister Luisa Alcalde announced that the daily minimum wage in Mexico will rise by a full 20% to 123,22 Mexican pesos (about $6.50)1. That's the second double-digit increase in two years, following the 16% hike in 2018, reformist President Andrés Manuel López Obrador's first year in office. Though lower than the 29% proposed by the country's minimum wage commission, the 2020 hike is roughly seven times the country's current inflation rate, which had slowed to 2.85% toward the end of November. 

About one fifth of Mexico's working population earned the minimum wage or less per day as of the first quarter of 2019 -- but other contracts currently in force are indexed to the rate, amplifying its impact on the economy. 

The move could slow the plans of Mexico's central bank to cut rates in the coming year, despite Presidential pressure to do so more aggressively. Combined with the impact of the recent trade agreement with the U.S. on the USMCA (the U.S.-Mexico-Canada Agreement) , economic growth in Mexico could become significantly more difficult to predict, with the increased prospect of upside surprises due to unexpected growth.
 

On the slide: British Pound: The Mourning After

The so-called "Boris Bounce" - the 3.5% updraft in the value of the pound vs. the dollar in the hours after the Tory victory was announced - was apparently temporary. As of Dec. 17, the pound had given up those gains - retreating to $1.3140 at midday London time, only slightly higher than on Dec. 12. The pattern was replicated in the bond market, with yield on 10-year Gilts rising some 12.7 basis points (bps) to as high as 0.763% before retreating about 10 bps to 0.764%.

Though the election removed one component of uncertainty from financial markets, it replaced them with several others, mostly involving the course and impact of Brexit on the rest of the European Union and the future of the UK itself. Added to that mix are the unanticipated side-effects and unknowable repercussions elsewhere, making any attempt to make plausible forecasts an exercise in futility. 

 

Note: The year for all dates is 2019 unless otherwise indicated


As of 12/17/19 10:45 AM ET. Source: Bloomberg.

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 Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System 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.

The European Central Bank (ECB) is responsible for the monetary system of the European Union (EU) and the euro currency.

The Agreement between the United States of America, the United Mexican States, and Canada is a signed but not ratified free trade agreement between Canada, Mexico, and the United States. It is referred to differently by each signatory-in the United States, it is called the United States-Mexico-Canada Agreement (USMCA); in Canada, it is officially known as the Canada-United States-Mexico Agreement (CUSMA) in English and the Accord Canada-tats-Unis-Mexique (ACEUM) in French; and in Mexico, it is called the Tratado entre M‚xico, Estados Unidos y Canad  (T-MEC). The agreement is sometimes referred to as "New NAFTA" in reference to the previous trilateral agreement it is meant to supersede, the North American Free Trade Agreement (NAFTA).

The Conservative Party, officially the Conservative and Unionist Party; also known colloquially as the Tories or simply the Conservatives, is a center-right political party in the United Kingdom.

Gilts are bonds that are issued by the British government.

A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

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.

The ECB Main Refinancing Rate is the main target interest rate set by the European Central Bank.

The ECB Deposit Facility Announcement Rate is the interest rate paid by the ECB on reserve deposits from member banks.

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