Morning Commentary: When Actions Don’t Speak Louder Than Words
A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
When Actions Don’t Speak Louder Than Words
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Andrew Kositkun Foreign Exchange Head Trader
It appears that perceptions on monetary policy can matter more to the markets than actions. The European Central Bank (ECB) represents a good example of this. On paper, the Fed has been more forceful in stressing its commitment to a new set of aggressive nominal and real objectives. By contrast, the ECB has been more ambiguous in its language around inflation.
But despite the market narrative that the Fed is actively increasing liquidity and contributing to U.S. dollar depreciation, data shows that the Fed is actually lagging the ECB in terms of balance sheet expansion over the past six months. During this time frame, the Fed has increased its balance sheet by 0.6% of GDP versus the ECB, which expanded its balance sheet by 10.3% of GDP. Even if you open this observation window to include the start of the pandemic when the Fed was much more aggressive, the ECB still outgrew its balance sheet relative to the Fed 18.4% to 14.3%.
This past week’s policy changes from the ECB only served to confirm that the central bank will remain at the forefront of the balance sheet race. At its latest meeting, the ECB added another 500 billion euro, or 4% of GDP, of additional purchases to its asset purchase program. In total, the announced asset purchase amount through the first quarter of 2022 now exceeds 20% of GDP. If you account for the additional asset purchases that are likely to accompany the completion of the ECB’s strategic review next September, total QE purchases since the start of the pandemic should amount to roughly 25% of GDP. Put another way, the ECB is set to out-ease virtually all other central banks. However, despite these numbers, the FX market remains dismissive of the ECB’s efforts to support financial conditions through its balance sheet. Presumably, this is because markets view the ECB’s actions as an inadequate response to the inflationary challenges the bank is facing.
This makes this week’s Fed meeting an interesting one. The Fed has hinted at the need to provide more accommodation due to near-term drags from the winter pandemic wave that is already showing up in labor market data. What remains to be seen is how the Fed goes about this. Should the Fed merely extend the maturity of its asset purchase program without increasing the size or pace of monthly purchases, then it would reinforce the narrative of a central bank that speaks loudly but swings a relatively smaller monetary stick, as it has not upsized any of its monetary stimulus programs since the initial pandemic response.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
Progress appears to have been made on U.S. fiscal stimulus talks, with some news outlets reporting that a package that would include a new round of direct payments may come this morning. But it needs to be noted that nothing has been decided, and it still remains unclear whether or not Nancy Pelosi and Chuck Schumer will be willing to push state and local aid and liability shields to the next round of talks.
The Fed will complete its two-day meeting today and is widely expected to leave rates unchanged. Instead, guidance should take center stage, with market participants looking for clues on the future of asset purchases and whether or not buying will be tied to employment and inflation.
U.S. retail sales fell 1.1% in November, which was more than consensus for a 0.3% decline. This disappointing report just adds further fuel to the argument for additional stimulus.
U.S. PMIs numbers came in mixed with manufacturing beating estimates at 56.5 versus consensus for a 55.8 print but services missing at 55.3 versus consensus for a 55.9 print.
Bank of Canada Governor Tiff Macklem, in a move unusual for the bank, expressed concern over Canadian dollar (CAD) strength by noting that the CAD was on the bank’s radar and that recent appreciation “does not reflect made-in-Canada factors.”
Eurozone PMIs came in much better than expected, as data rebounded significantly in December. The services number came in at 47.3 versus expectations for a 42.0 print, and manufacturing came in at 55.5 versus expectations for a 53.0 print. The services number benefited from improved virus conditions and looser restrictions, while global trade remained supportive for the manufacturing number. Note that survey data was gathered between Dec. 4 and Dec. 15, meaning this month’s number does not reflect recent restrictions, such as those imposed in Germany. So while it seems that the eurozone has done well through the first stage of the second wave, it remains to be seen how it will manage the second stage with much harder lockdowns.
Brexit headlines continue to strike an upbeat tone. Reporting out of the BBC indicates that the U.K. has made major concessions on the fishing issue, which both sides have positioned as a major point of contention. Of course anyone following Brexit is well aware of how many times headlines and actual developments have diverged.
Australia will challenge Chinese actions at the World Trade Organization (WTO). Trade tensions, which stemmed from Australia’s request to look into the origins of COVID-19, have been building for a while. Australia’s appeal to the WTO could be an attempt to stop the conflict from spreading further. On the economic front, Australia has reported positive PMI data, with manufacturing and services both rising from November’s print.
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