Define: “normalization.”
The thing about DM central banks rolling back accommodation is that they are so far down the rabbit hole at this point that climbing back out and thereby returning to a state of affairs that can be appropriately characterized as “normal” would take years if not decades.
The reason it would take so long to return to some semblance of normalcy has as much to do with how the market would react as it does to how large the balance sheets are. And indeed the market’s anticipated reaction and the scope of the accommodation are inseparable. Because the broader the scope, the more entrenched the market dynamics those policies engender become. Before you know it, the “state of exception” becomes “permanent.”
That’s the reality facing the ECB as the governing council tries to figure out how to go about normalizing in a way that doesn’t destabilize markets. Their situation is complicated further by the FX dilemma. The euro is off its highs hit in late August and early September, but it’s still up dramatically on the year and so, if the market perceives Draghi as coming across “too hawkish”, he risks adding fuel to that rally, a state of affairs which could put additional pressure on European equities in addition to the natural pressure that would come with the central bank mitigating the hunt yield by taking their foot off the accommodation accelerator.
So that’s the backdrop for the news that the ECB is set to cut QE in half starting in January while extending the program for at least 9 more months. “Reducing quantitative easing to 30 billion euros ($36 billion) a month from the current pace of 60 billion euros is a feasible option,” unnamed officials say, citing the privacy of the deliberations when asking for anonymity.
“The package seems to mean that yes, the ECB is taking a step down, but there is enough in terms of communication and guidance to keep markets calm and make sure financial conditions remain easy,” ABN Amro’s Nick Kounis, told Bloomberg, adding that “there seems to be a consensus on this coming together [as] some of the more hawkish members understand that you have to wind down QE very gradually.”
Yes, “very gradually.” Or preferably “not at all.” But like the Fed, they’re going take some baby steps and see how things go.
Because the proposed taper is in line with consensus, but more importantly, because it represents the extension of the program for nine months at least, European bonds are rallying. Bunds led the way with the gains underpinned by a large block trade.
For now, let’s reserve judgement on the euro because it doesn’t seem like it wants to figure this out on Friday. By the end of the month, it could very well revisit local highs.
“The euro is likely to revisit end-September highs late this month after the ECB announces its tapering plans,” Rodrigo Catril, a currency strategist at National Australia Bank Ltd. in Sydney said late Thursday.
As for stocks, well, they’re up because while Draghi doesn’t want to be exclusive with you anymore after January, you can still Netflix and chill for another 9 months.
