Yesterday, in “Thoughts On The ECB Minutes And A Bearish Euro Call For EURUSD Bulls“, I spent far more time than I should have talking about the conundrum facing the ECB now that the data appears to be rolling over just six months ahead of the sell-by date for APP.
The problem here is that they’re now trying to move further down the road to normalization at a time when the econ is coming in unexpectedly weak and just as trade jitters dent the outlook for global growth. Additionally, the notion that the Trump administration has adopted a weak dollar policy by proxy means that persistent euro strength could exacerbate any nascent weakness in the European economy and, perhaps more importantly, could imperil the slow progress towards the ECB’s inflation target.
The March minutes revealed an ECB that’s concerned about the market misreading the removal of the dovish slant on APP where “misreading” means traders thinking it’s an indication that the governing council is somehow hamstrung in their ability to ramp asset purchases back up should things get dicey. That concern was one reason why everyone interpreted the minutes as “dovish”.
Ok, so with that in mind (and because I’ve got a demonstrable penchant for talking about things that no one cares about on a Friday), BofAML is out with “3 reasons the ECB can’t get more hawkish” and they’re worth a quick skim.
The first is “too much debt” (incidentally, BofAML made this point in a note last week as well).
“Central banks have spent more than $10 trillion of QE-money over the past decade in an effort to reflate the global economy [and] in the process, they sparked a debt super-cycle,” BofAML’s Ioannis Angelakis writes, before observing that “while global debt has mounted to more than $160 trillion (government, household and non-financials corporate debt), global GDP is just above $60 trillion.”
The ultimate irony here – and this goes back to last week’s discussion mentioned above – is that central banks have been hard at work trying to engineer inflation which, presumably, could help alleviate the debt problem. So what happens if they take their foot off the accelerator in terms of accommodation just as inflation starts to move in the “wrong” direction? In that regard, the bank notes that when it comes to inflation trends in Europe, “the current ‘re-adjustment’ of inflation expectations is among the sharpest we have ever seen”:
Moving right along, the second reason the ECB can’t afford to get too hawkish is because while they’ve succeeded in bringing funding costs inline across the bloc (i.e. ensuring that periphery sovereigns and corporates aren’t paying enormous premiums to finance themselves compared to core), there are still disconnects that are feeding populism and therefore leading to heightened political risk in the periphery:
Finally, here is BofAML with the third reason the ECB can’t get too hawkish and it’s basically just a reiteration of the data rolling over point:
The ECB needs to be patient as they wind down QE: macro indicators are slowing down as PMIs and inflation prints are decelerating (chart 12 and 13). Additionally the main reason why the ECB stepped in in 2012 was to allow the periphery to deal with a rising debt pile. Higher growth and more importantly higher inflation would balance the gap vs. the core. Unfortunately the trend has been exactly the opposite. Chart 14 highlights that the inflation trajectory in Italy has been “underperforming” notably that in Germany.
All of this just further underscores the notion that DM central banks might have waited too long to normalize. That is, this was always about starting this process before the data starts to roll over again, because if you wait too long and the cycle turns on you while you’re still sitting in NIRP with a bloated balance sheet, well then where do you go from there?