Following Mario Draghi’s comment that the ECB would do "whatever it takes”, this week’s ECB meeting (Thursday 2145 AEST) takes on a whole new level of interest. And importance. There was a sharp drop in Spanish bond yields – down almost 100 bps(!!) to 6.73 per cent – and a strong stock rally over the last two sessions, with the S&P500 up 3.5 per cent for two days.
We even saw a 1 cent gain in the Australian dollar (1.0473). All of it was sparked by the ECB – and of course comments on Friday night from German and French politicians seemingly backing the ECB’s position. There is ample scope then for the market to be ‘disappointed’ as is often the case, more so when the bond market has clearly ceased to function rationally.
Most analysts it seems don’t expect the ECB to cut interest rates and the forecast is they will remain at 0.75 per cent after this meeting. They could announce, however, a new more aggressive bond buying program with a stated ceiling for yields, or offer a new long-term refinancing operation – where they effectively issue monies into the financial system, to be turned back toward Spanish and Italian bonds.
Either way, and as much as I think it is a mistake to constantly indulge the market this way, it is certainly superior to a formal Spanish bailout. If Europe does this, the necessity of an Italian one is guaranteed. As was Spain’s when the Europeans restructured Greek debt. This should never have happened. It did, as I warned, just feed the contagion, not halt it – and the cost to Europe has been unnecessarily huge.
Perhaps less interesting will be the Fed’s meeting (Thursday 0415 AEST) and there is plenty of speculation that QE3 may be delivered at this meeting, although I don’t think that is the consensus expectation. I can see the tactical advantages, from a PR perspective, that might lead the Fed to do it now. It is very convenient to do it while the data has softened. To take advantage of the usual volatility in the data that we have seen every year so far, and monetise more debt.
But for mine I still think it’s a bit premature, given we have the fiscal cliff theatrics (FCT) at year-end. My view presupposes some kind of limit to QE though and this assumption I admit, is a weak one. We have, in all seriousness, Fed officials who have publically suggested an opened-ended QE policy, with no target amount, securities or end. It would be a much more honest approach, sure, and I love honesty, but very dangerous and it would make a complete mockery out of monetary policy and central banking more generally. As it is, it is almost impossible to forecast central bank actions on any of the usual metrics – growth and inflation. Such a decision would exacerbate this problem and add to the already considerable financial market and real economic volatility.
Outside of the Fed there is a significant run of US data to contend with as well. It’s shaping up to be a huge week. The highlights, naturally, will be the ISM survey on Wednesday night – where a modest increase back above 50 is expected – and payrolls on Friday. Payrolls are expected to show an increase of 100,000 for July, which isn’t enough to stop people talking about stall speed growth. It's just like last year and the year before that, but still not inconsistent with my view (which has proven to be the correct one over these past few years) that the data just bounces around and the recovery remains intact. And, in fact, is still solid with growth at trend.
Similarly, Australia has a big data week and of course earnings season kicks off. For the first half of the week, most of the Aussie data is concerned with the housing market. It's weak, we know, but there had, prior to the RBA’s rate cuts, been good signs of a pick-up in lending. We’ll get an update on the lending side with the RBA's credit measures on Tuesday at 1130 AEST. It's fair to say that so far, rate cuts have not helped one iota. House prices, conversely, look to have at least stabilised and may even be picking up. But this is less to do with the success of RBA policy and more to do with the fact that we’re not building anywhere near our underlying requirement. It is this failure of public policy that can be expected and is, underpinning rental and house price growth.
Thursday sees another retail spending update (1130 AEST), where the market looks for a solid rise in both the month of June and the June quarter. Other than that we get more trade figures – at the same time.
Have a great week…