The ECB meeting held on April 21st didn't bring anything new. As widely expected, rates remained on hold, and there weren't any announcements of new measures of alternative monetary policy instruments. After the meeting, details regarding the Corporate Sector Purchase Program were released.
But the Q&A session was interesting, as always. I would highlight the observation made by the ECB president regarding the profitability of the banking system when commenting the effect of negative interest rates:
"We have no evidence that it hampered the transmission of monetary policy, and when we look at bank profitability, we see that 2015,the first full year with negative interest rates has not affected, or has not caused negative interest income, net interest income going down. As a matter of fact, it went up. Now, of course we've got to be cautious here because we talk about the aggregate of the banking system in the euro area, and of course aggregates may actually conceal different realities. We also saw no significant evidence that these negative rates had been passed through to the depositors or to the borrowers from the banking system. So all in all the experience has been positive. Then one asks oneself, 'Is this positive experience going to be true for any level of interest rates?' and the answer is no, of course. So the issue of negative interest rates is not so much an issue of yes or no; it's an issue of extent."
In this scenario, voices from the financial sector criticizing the monetary authority seem inadequate and they are probably more a reaction to the possible extent of the policy than to the policy itself.
In fact, in US, rates have been negative for longer, and banks apparently are in better shape than European ones. The economy itself is also in a better shape, and pass-through mechanisms were not deterred by policy. This means that probably further rate cuts in the eurozone are likely and the current stance will very unlikely change before the end of the asset purchase program.
The consequences may be increased demand for loans while savers should continue looking for alternative assets to invest at higher returns (or at a return), namely in the USD universe, contributing to a stronger USD currency and downward pressure in the American yield curve.
In the US, the monetary authority in the last meeting, albeit reinforcing the data dependency of rates, adopted a dovish speech, showing an increasing focus on the international environment, and probably was not thinking only about emerging markets and commodity prices, but also about their central banking peers. Recently, some FOMC members have come to stage with less dovish words than those prevailing at the meeting, which doesn't warrant the tone of the next meeting, coming up in the last week of April, will change.
Making a little of retrospective, since the beginning of 2016, both the eurozone and US monetary policy makers have been more dovish than expected. However, when looking at economic and financial market data, in the eurozone such stance is justifiable by inflation and growth-related indicators, but in the US, it's not, as activity and inflation have picked up, in particular the Core PCE, FOMC's preferred inflation measure, showing an upward trend since mid-2015. In this environment, my interpretation is that such dovish stance from the FOMC can only be explained by international factors that affect the American economy, such as the foreign exchange and yield levels.
In fact, when looking at EUR/USD and government yields evolution since January 2016, we see that yields have fallen both in the US and Germany. However, the difference between 10-year yields in the US and Germany has fallen at first to return to 162 bps, the same level as in the beginning of the year; in two-year maturities, the spread fell from 145 bps to 129 bps while the EUR gained value against value against the USD.
This suggests that the communication by the FOMC has been more impactful than ECB's. Despite the FOMC remaining committed to a data-dependent path for rates, I expect to continue seeing a dovish FOMC next week at the monetary policy meeting, which should add downward pressure to the American yield curve, probably more pronounced in the short segments. Demand for higher-yielding investments by European savers should also be a factor weighing to bring down the American yield curve.
The limit for the effect of communication is credibility, and such credibility is supported by economic data. US economic data in my view does not support a dovish stance even if the FOMC is more willing to maintain rates lower than raise them prematurely.
With economic data out from the US continuing to surprise on the upside, it will be difficult for American policymakers to sustain a downbeat rhetoric for long, which in my view, aims primarily at stabilizing the currency than anything else. On the other hand, less dovish words could lead to a resumption of USD appreciation and rising interest rates and yields in the US, which are not positive for the American economy, especially if they are fast.
In this environment, USD appreciation against the EUR and higher yields in the US seem like the trends that make sense, but only to the "extent" they are tempered by FOMC's words and interventions, so that the path is walked slowly.
Such slow path is a restriction to Mr. Draghi's policy reducing its ability to affect the eurozone economy in its full extent. Probably that's the "patience," referred to in the last ECB meeting.
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