Friday, January 22, 2016

ECB Meeting: Stimulus Redux

It was rather a bit surprising for the ECB to signal its willingness to review its monetary policy stance as early as in next meeting in March. President Draghi was quick to point out that this decision was unanimous within the governing council. Which is a very strong sign.
This will definitely bearish for euro, and bullish for the equities in the short term. And this puts further pressure on the Fed/ ECB policy gap.
A lot hinges on the economic report that ECB expects to be available before the next meeting date. It seems to me that ECB and other central banks (especially Fed) sees energy price shocks to inflation a bit differently. Fed has long a stance (supported by its own research) that post 70s, the pass-through effect of energy prices have been rather muted and transient, to headlines inflation and especially core inflation measures. This also held through as monetary policy measures subsequently became less responsive to energy price shocks. However, ECB considers the second-round or indirect effect of energy shocks seriously. According to its own study, a 10% change in oil prices gives rise to a non-transient 0.2% impact on the HICP (over a period of up to 3 years). Given the recent moves since last ECB meeting, this can explain as high as 0.6% decline in HICP inflation. Most probably a stimulus is on its way.
The question is more of effectiveness. From the levels of early 2014, the first round of ECB QE in 2015 achieved a reduction in real rate of almost 80bps (bottomed out in April 2015), almost all of which was given away by August. From pre-QE expectation in early 2014, the net impact on the real rate of a EUR 1.5 trillion asset purchase program, along with multiple rate cuts, amounts to a mere 35bps in terms of real rate. Given where the nominal rates are now in Europe, the next round will have much less impact. Monetary stimulus is limited at current scenario without strong Fiscal support, which is not seen forthcoming in Europe at all. Not any time soon.
Separately, the emphasis on the review of monetary policy was hardly something to be missed in the following press conference. Given the limits, in terms of how negative depo rates can go, and potential operational limitation around public asset purchase, there is a good chance that come March, we risk another disappointment from the ECB. But of course it will be nice to be surprised on the upside.

The comeback in today's market is far from certain to sustain. We are nowhere near the panic in 2008, or even 2011 sell-off. As they say, there is not yet enough "blood on the street". See below the CBOE implied correlation index. As they imply, the sell-off is still scattered, and yet to become something secular.


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