Well, it’s Sunday evening and you know what that means – that means that unless Donald Trump tweets us into the nuclear apocalypse overnight, tomorrow will be Monday.
Of course assuming something won’t go horribly wrong in the middle of the night is never a completely safe assumption these days given the hopelessly fraught geopolitical backdrop, so it’s also worth doing your best Phil Connors impression…
That’s right: “What if there is no tomorrow? There wasn’t one on January 21st.”
The main event this week will of course be the ECB and the turmoil in Spain makes things even more interesting than they would already be. Draghi is widely expected to outline the future of QE in Europe and it comes against a backdrop where the Catalan independence bid could imperil periphery spreads. Here’s the bottom line as summed up by Barclays:
President Draghi and Peter Praet have repeatedly insisted on the need to preserve a high degree of monetary policy accommodation, in order to maintain a supportive financial environment, which is still necessary to achieve the ECB goal of price stability. Lending to the economy has continued to improve over the summer, and our in-house measures of monetary, credit and market conditions have so far remained unaffected by short-term market volatility (in particular the FX market) and suggest that overall, financial conditions are still very supportive. Therefore, we believe that the GC will feel more comfortable at its October meeting next week to announce the long awaited “calibration” of its monetary policy framework, i.e. a reduction of the pace of asset purchases as from January 2018.
This telegraphing was itself telegraphed (remember: there’s now forward guidance for the forward guidance – that’s how absurd things have gotten) earlier this month when Bloomberg reported that the ECB is set to cut QE in half starting in January while extending the program for at least 9 more months. As we put it, “the ECB is going to cut QE in half, but you and Draghi can still ‘Netflix and chill’ for another nine months.” Good luck scrubbing that from your mind.
It seems likely they’ll be another round of this before it’s all said and done – that is, they’ll end up extending it again past September 2018 while cutting the total in half one more time. Here’s Goldman:
We expect the ECB to implement its monetary policy stance using a combination of asset purchases and forward guidance. We expect the ECB to announce a 12-month tapering of the APP, while maintaining its current expected sequencing of no policy rate hike until ‘well past’ the end of net asset purchases. A 9-month open-ended extension is also likely (given recent ECB communication) and we overall have less conviction in the exact announcement at the October meeting. Such an open-ended scenario would likely still imply a total of 12 months of purchases (with further extensions announced in June or July next year). In either case, continued purchases for 12 months, together with the ‘well past’ language on policy rates, would effectively signal a first rate hike well into 2019. Bond scarcity considerations limit the length of asset purchases. Our base case considers the trade-off in terms of length of purchases (and its implication for forward guidance), with the ECB’s view that any changes to the purchase pace should be gradual and ‘prudent’.
As far as the scarcity bit is concerned, German debt is obviously the constraint. Here’s Goldman on that from a note out a couple of weeks ago:
We model three different APP tapering calibrations. For each scenario, we identify the point at which German net purchases (allocated by the capital key) would reach the issue/issuer limit. For ease of comparability, all three scenarios are calibrated to amount to EUR360bn in total purchases if run until the end of the 2018.
This analysis requires a range of technical assumptions. Our broad approach is to assume that the Eurosystem maintains the present parameters of the progamme (aside from those which we adjust for the scenario analysis). We assume a mechanical application of the capital key. For each scenario, we apply the assumption that the ECB tapers the PSPP first (as was case when the APP was adjusted in from EUR80bn to EUR60bn of net purchases).
- Our baseline: A 12-month (linear) tapering of the APP at a rate of EUR5bn per month. Under this scenario, the front-loading of purchases would cause scarcity to be reached in Germany in 2018Q2, absent any other adjustment or changes to the self-imposed constraints.
- Stepwise: A reduction in total APP purchases to EUR40bn for 6 months, followed by a further reduction to EUR20bn. Under this scenario, scarcity would be reached in Germany mid-year 2018.
- Constant: A reduction in total APP purchases to EUR30bn for 12 months. Under this scenario, scarcity would be reached in Germany in 2018Q3.
If you’re looking for market turmoil around this announcement you’ll probably be disappointed. Draghi will thread the needle. He always does. Sure, the program itself is absurd and CSPP has created all manner of ridiculous distortions (see € HY for example), but once you accept that the whole thing is ludicrous on its face, Draghi has become a master of getting the messaging “right.” Maybe this time is different, but we doubt it. Over the longer-term, there are obviously questions as to what the taper will mean in terms of putting more of the onus on the market when it comes to filling the gap left by the taper, but that’s more an existential question about what happens in the post-QE era. Actually testing Draghi while the program is still in place is a dangerous game to play.
Here’s a handy projection from Barclays:
This is all set against the fractious (figuratively and literally) situation in Spain, where the standoff between Rajoy and Puigdemont will continue. Rajoy is going to delay his weekly cabinet meeting on Friday until the Senate has voted on Article 155 – included in the measures is of course the suspension of Catalonia’s autonomy and the removal of Puigdemont along with his cabinet. For his part, Puigdemont is weighing a unilateral declaration of independence followed immediately by an election. So you know, that’s obviously a disaster waiting to happen.
Markets will continue to digest the results from the Japanese election that saw Abe’s ruling coalition retaining a two-thirds majority in the lower house:
That effectively ensures that everything the following visual represents is going to continue for the foreseeable future:
Here’s some color from BofAML:
The result is fundamentally positive for the equity market as political stability should be restored and Abe’s economic policy will likely continue. Near-term, we may see some profit taking given the magnitude of foreign buying of Japanese equities in the weeks preceding the election (¥3tn net purchase over 3 weeks, a record). The policy priority is likely to shift toward national security and constitutional reform, away from economic reform. Unlike in 2012 or 2014, a margin of expansion in the fiscal policy is also limited.
However, Japanese equity market is backed by solid fundamentals and long-term positioning remains light. We believe the election result reduces one key risk factor of political stability and support the equity market over the medium-term.
USD/JPY: Downside risk reduced, top side interest may grow further. We had recommended selling rich USD/JPY skew as we thought the risk to JPY would be much more symmetric than the option market was pricing in. In the cash space, USD/JPY positioning may be relatively light, judging from the price action in each timezone and our quant model. As the chance for Governor Kuroda’s reappointment or replacement by a similar dove has grown, JPY is likely to remain as a preferred funding currency in the global financial markets. We continue to see upward pressure on USD/JPY over the medium-term.
Meanwhile, back at the stateside Ponderosa, we’re all waiting on Trump to announce his Fed pick and you can be absolutely certain that he knows what he’s doing in that regard because this is what he told Maria Bartiromo in an interview:
I have a couple of other things in my thinking. But I like talent. And they are both very talented people. And it’s a hard decision. It’s actually a very important decision. People have no — most people have no idea how important that position is. That position is actually — more — a lot of people get rid of the Fed.
Take the Fed out. That’s a very important position. It’s also important psychotically.
There you go. What could go wrong?
There’s also a BoC meeting this week. Simply put, if Poloz were to hike again it either means he knows something everyone else in the world doesn’t or else he needs to be committed immediately. No, not really, but they’ve broken the mold and so everyone is watching. Here’s Goldman:
We expect the BoC to stay on hold at the October meeting, highlighting the Governing Council’s plan to act “cautiously” to monitor the effects of the recent rate hikes in July and September. The MPR will likely add the output gap is now about closed, while stressing that “full capacity can be a moving target.” However, capacity pressures have risen and we expect the BoC to feel inclined to raise rates again in December. A cautious MPR and press conference could mean a further delay in the next rate rise.
And then there’s the Riksbank (always funny) and the Norges Bank as well. “In Canada, we do not see BoC to hike rate this Wed, instead, it will have a gradual hiking cycle in 2018 with three 25bp hikes in Jan, Apr, and Jul,” BofAML writes, adding that “both the Riksbank and the Norges Bank are likely to remain on hold adopting a wait and see approach ahead of the ECB.”
Besides Catalonia, Iraq still looms large on the geopolitical front. Washington isn’t pleased with the ambitions of Iran’s proxies and revelations that everyone’s favorite ghost, Qassem Soleimani, was behind the seizure of Kirkuk underscore the extent to which Tehran had a definitive plan for a post-ISIS Iraq while Washington did not. Now Rex Tillerson wants Soleimani’s proxy armies to stand down. That’s not really how this works, Rex. You don’t get to use them to defeat ISIS and then simply instruct them to “go home.”
Finally, there’s all kinds of econ this week which you can preview in the calendar embedded below.
Full calendar from BofAML