To be sure, the ECB’s Villeroy didn’t say anything that was particularly groundbreaking on Monday, but what he did say underscored the central bank’s desire to get on with it (as it were) when it comes to calling an official end to APP and thereby opening the door to liftoff. As detailed in the linked post, that set off a flurry of bearish trades and as Bloomberg’s Richard Jones notes on Tuesday, “a 10bp hike is now fully priced at the June 2019 meeting.”
“Villeroy turned focus back on the ECB’s exit from QE — a notion that had taken a backseat to the 1Q data soft patch and geopolitical risks,” Jones adds.
Right. And the problem here is the same as it ever was. This is a race against the clock to free up counter-cyclical breathing room before the next downturn. You don’t want to end up in a scenario where the data turns decisively and sustainably negative when the balance sheet is still bloated and rates are still negative or, at “best”, hugging zero.
That would be “quantitative failure” and you’re reminded that thanks in no small part to the soft patch in eurozone growth in Q1, it was back on the radar for European credit investors last month.
That flip from “inflation” to “QF” on the list of biggest risks is notable, as it shows you how quickly credit investors across the pond went from worrying about a sustainable, rapid rise in inflation forcing the ECB to wind down APP perhaps more quickly than expected to worrying about weakening data creating a scenario where, to quote the BofAML survey that visual is from, “a lack of inflation traction into year-end – just as the ECB, for political reasons, has to end QE – forms a toxic combination.”
Well over the past 24 hours, you’ve seen a kind of microcosm of that between Villeroy’s comments and, on Tuesday, more evidence of a softening Eurozone economy. The German economy expanded 03% in Q1, more sluggish than forecast and a notable deceleration from Q4. More generally, growth slowed across the bloc.
The euro is still having a tough time getting any traction, having pared all of the gains following Villeroy’s Monday “hawkish” lean:
The situation in Italy isn’t likely to help matters as it raises the specter of a less integrated Europe (even if breakup risk remains infinitesimal) and also the prospect that, if periphery spreads were to widen significantly, the ECB might have to tap the brakes on a normalization push that’s not moving very fast in the first place.
All in all, everything said above raises the “ammo” question again and that’s just about the most vexing issue imaginable when it comes to the evolution of monetary policy in a post-post-crisis world (and no, there are no typos there).