- November Nonfarm Payrolls: +321K vs. consensus +225K, +243K previous (revised from 214K).
- Unemployment rate: 5.8% vs. 5.8% consensus, 5.8% previous.
ECB Holds Fire on New Action The European Central Bank opened the door to a dramatic escalation in its campaign to stimulate the eurozone’s stagnant economy, but deferred any moves until early 2015.
ECB President Mario Draghi said Thursday that officials discussed purchases of government bonds, otherwise known as quantitative easing, a move that would mark a new chapter in the bank’s fight against excessively weak inflation. But he added they needed more time to gauge the effects of policies that they had already implemented while assessing how falling oil prices might affect the region’s already weak consumer prices.
“We discussed the possibility of doing QE” with buying government bonds “as one option,” Mr. Draghi said after the ECB left its key interest rates unchanged at record lows at the bank’s monthly meeting. The ECB will reassess its policies early next year and decide whether it needs to do more, Mr. Draghi said, raising expectations that the ECB could act as soon as its next policy meeting on Jan. 22, although he didn’t commit to a time frame.
“Early means early. It doesn’t mean at the next meeting,” Mr. Draghi said.
Financial markets reacted negatively despite Mr. Draghi’s suggestion that bolder action could come soon, as investors had hoped for a more ironclad commitment to begin large-scale bond purchases, a policy that has been used extensively by central banks in the U.S., the U.K. and Japan. European and U.S. stocks fell Thursday, and the euro rose on Mr. Draghi’s comments.
Draghi did not say “soon”, he said early, like “early as a teenager on Saturdays”…But on Nov.20, he did say “without delay” and “as fast as possible”. It now appears that may not be possible soon. Anyway, we now know that “early means early”.
But markets don’t seem to care what early or without delay or as fast as possible mean:
“They’re almost there but not quite over the line,” said Ken Wattret, economist at BNP Paribas. “The pieces of the jigsaw are falling into place.”
Blind trust in the saviour who says a lot more than he does.
The ECB opted against immediate action despite an annual inflation rate of 0.3% in the eurozone in November, far below the central bank’s target of just under 2%. The ECB lowered its 2015 forecast for consumer-price growth to 0.7% from 1.1% and in 2016 from 1.4% to 1.3%. The inflation forecasts didn’t fully incorporate the most recent drop in oil prices, which could push inflation even lower. (…)
BTW, there are new pieces to the jigsaw:
Mr. Draghi’s remarks contained a number of hints that more central-bank stimulus may be coming to Europe soon. He said the ECB would be “particularly vigilant” about the effect the sharp reduction in oil prices could have on consumer prices and expectations for future inflation, using a phrase that his predecessor, Jean-Claude Trichet, often deployed to signal imminent ECB action. (…)
Mr. Draghi suggested that the ECB would move even in the face of German opposition if the ECB’s inflation target was at risk. “We don’t need unanimity” to launch quantitative easing, he said, adding that he was confident a program could be designed to achieve a consensus within the ECB, if needed. The ECB could also purchase other private-sector assets, he said, saying officials have discussed all types of assets except gold. (…)
It’s one thing not having unanimity, it’s quite another thing to go against Germany. Ambrose Evans Pritchard seems to agree:
ECB paralyzed by split as irreversible deflation trap draws closer ‘It is now patently clear that Draghi lacks the crucial German support for launching full-blown QE’
(…) Crucially, he revealed that the EBC’s six-strong Executive Board is divided on the bank’s vague pledge to boost the balance sheet back “towards” the levels of early 2012, an implicit €1 trillion commitment. (…)
Mr Draghi’s failure to secure the full assent of his own board is a major headache. The mood is entirely different from events in 2012, when he launched his “do-what-it-takes” plan (OMT) to act as a lender of last resort for Italy and Spain. That plan had the full backing of the (then) German board member and the support of Chancellor Angela Merkel, who preferred ECB action to another traumatic bail-out vote for Club Med debtors in the Bundestag. This time Mr Draghi faces stiff resistance from across the German establishment.
While the ECB Council operates on a basis of one-man, one-vote, there would be a political storm if full-scale QE was forced through by an Italian ECB president at the head of a “Latin bloc” of debtor states against explicit German objections. Such action would be a recruiting trumpet for Germany’s AFD anti-euro party and would endanger German popular consent for monetary union. The scale of such action might also infringe on the Bundestag’s budgetary sovereignty, and violate Germany’s Basic Law.
Mr Draghi is understandably loathe to take such a hazardous step, forced to bide his time in the hope that Berlin will gradually yield as deflationary forces threaten Germany itself.
This may happen. Data collected by Marchel Alexandrovich, at Jefferies Fixed Income, show that the number of goods in Germany’s price basket in outright deflation jumped from 22.9pc in September to 31.2pc in October.
The ratio is 36.7pc in Italy, 40.9pc in Spain, 41.7pc in Holland, 43.6pc in Portugal, 54.1pc in Slovenia and 85pc in Greece. Japan’s experience in the 1990s showed that the process is very difficult to reverse once the deflationary effects reach 60pc. (…)
The implication is that Euroland risks falling into an almost irreversible trap if the ECB fails to take pre-emptive action immediately.
Euro-Area Growth Held Back by Investment Drop in Third Quarter Euro-area investment fell for a second quarter, holding back growth and underlining the weakness in the economy that prompted the European Central Bank to cut its forecasts.
Investment declined 0.3 percent in the three months through September after a revised 1.2 percent decline in the previous quarter, Eurostat, the European Union’s statistics office in Luxembourg, said today. Gross domestic product increased 0.2 percent, matching an initial estimate published last month.
Bundesbank cuts German growth forecast Central bank predicts economy will expand 1% next year
(…) Germany’s central bank now says the country’s economy will expand 1.4 per cent this year, 1 per cent in 2015 and 1.6 per cent in 2016. In June, it had expected growth of 1.9 per cent this year, 2 per cent next year and 1.8 per cent in 2016. (…)
The Bundesbank cut its price projections to 0.9 per cent this year, 1.1 per cent in 2015 and to 1.8 per cent in 2016. It said, however, the rate of inflation excluding energy was likely to increase to 2 per cent in the year after next as wages rose. In June, inflation forecasts stood at 1.1 per cent for this year, rising to 1.5 per cent in 2015 and 1.9 per cent in 2016.
Lately, corporate credit has become more risk averse, while the common equity market has become more tolerant of risk. Compared to its 376 bp average of 2014’s third quarter, the high yield bond spread widened to a recent 380 bp. It was in June 2013 that the month-long average of the high yield bond spread was greater than 480 bp. Coincidentally, at the start of the previous two extended series of Fed rate hikes, the high yield bond spread was less than 400 bp.
Similar to the broadening of the high yield spread, the long-term Baa industrial company bond yield spread has widened from a Q3-2014 average of 152 bp to a recent 186 bp. Also, the month-long average of the Baa industrial spread last surpassed 186 bp in June 2013.
At exactly the same time that corporate bondholders are demanding higher yields as compensation for a perceived increase in risk, equity investors are accepting less in terms of core profits when purchasing common stock. For example, the year-long ratio of profits from current production to the market value of US common stock dipped from a Q3-2014 average of 10.1% to a recent 9.8%. It was in 1997’s third quarter that this measure of equity-market risk aversion last fell in a similar manner.
For a sample commencing with 1987’s final quarter, the yearly changes of the high yield bond spread and core profits as a percent of the market value of common stock generally conformed to expectations — that is the credit and equity markets both turn more, or less, risk averse — 61% of the time.
Often when they disagree or move in different directions, the high yield bond market ultimately proves more prescient than the equity market. The late 1990s offers a prime example of when the credit and equity markets disagree on risk, the credit market often ends up winning the dispute. Notwithstanding a widening by the high yield bond spread from Q4-1997’s 337 bp to Q1-2000’s 522 bp, core profits still sank from 9.5% to 6.0% of the market value of US common stock. What is especially noteworthy about this unmatched overvaluation of common equity is how the span’s 49% cumulative increase by the market value of common stock not only defied the accompanying -5% drop by core profits, it also seemed oblivious to a rise by the US high yield default rate from 2.4% to 5.9%.
In addition, an incredibly excessive overvaluation of equities can be inferred from how the market value of US common stock soared higher by a cumulative 99% from December 1996 to March 2000 despite an accompanying ascent by the US average high yield expected default frequency metric (EDF) from 3.6% to 8.6%. The aggregate high yield EDF metric functions as a helpful indicator of where the default rate is likely to be one year out. The latest high yield EDF metric of 2.7% is consistent with an outlook for defaults that should not be disruptive to financial markets.
The EDF/NAI model — employing the US average high yield EDF metric, the three-month change in the average high yield EDF, and the latest moving 12-month average of the Chicago Federal Reserve Bank’s national activity index (NAI) — does a remarkably good job of explaining the high yield bond spread. This approach shows that the recent high yield bond spread of 480 bp is close to its predicted value of 460 bp.
Thus, the EDF/NAI model suggests that the market has not been unduly harsh in its pricing of high yield bonds. If anything, the market may be too generous in its pricing of common equity.