When the consensus begins to roll-over

Latest on the weekly investment view from NBAD's Managing Director & Head of the Global Asset Management

Claude-Henri Chavanon

Published: Updated:

Growing pressures in various markets are causing short-term volatility to increase, and investors are likely to question strategies that have worked well over the medium-term - and, yes, it’s all rather uncomfortable.

It has been a very busy week or so, including China being formally invited into the IMF’s SDR ‘club’, a significant update regarding ECB monetary policy, an interesting OPEC meeting, and the last important U.S. economic statistics before the Fed (with 79% certainty, we are told) raises rates on the 16th of this month.

In the U.S., Non-Farm Payrolls for November came in at 211,000, a bit above the consensus, although the really significant aspect was that October’s increase was revised up from 271,000 to a very large 298,000 - way above the original highest expectation of 250,000 from 75 analysts.

Notwithstanding a major external event, the Fed is practically certain to raise its Fed Funds rate. Unemployment held steady at 5%, and average hourly earnings rose 0.2% month-on-month, with the year-on-year rate moderating slightly from 2.5% to 2.3%. Although recent employment growth is above most measures of the ‘break-even’ rate for jobs, this and the rise in earnings has not properly followed-through to GDP growth because of poor productivity growth, quite apart from the well-known fact that the true rate of unemployment is actually a multiple higher than the official number.

Fed Chair Janet Yellen indicated in a speech last week that the U.S. economy is strong enough to cope with higher rates, although the Fed would be cautious (i.e. that interest rate increases should be gradual). Although the manufacturing side of the economy continues to be sub-par, the ISM non-manufacturing (services) PMI for November came in at 55.9, showing continued expansion, even if it didn’t match expectations.

Turning to the ECB’s statement on its monetary policy, the euro saw its sharpest gain against the dollar since the original U.S. QE announcement in 2009, following market disappointment that the ECB’s monetary accommodation will remain unchanged, at €60 billion/month.

The market was expecting this to increase to about €80 billion/month, to maintain its regular ‘fix’ of increasing required liquidity injections, and had sought a bigger deposit rate cut than was delivered (see below). ECB President Draghi indicated an increase in the duration of those unchanged amounts (by at least six months, through to March, 2017), but that was dismissed by market participants, who wanted extra accommodation to be front-end loaded rather than ‘promised’ into the future.

Last week we touched on the problematic realities of operating with negative interest rates, as the ECB is doing, including the shrinking number of quality credits available for it to buy. Unfortunately, just as we thought in months past in relation to the Fed’s actions, a fair reaction is, ‘What a mess’; there was either (a) a communication error on the part of the ECB, i.e. they didn’t bother to properly manage expectations, or (b) the ECB changed its mind, and scaled-back the amount in the face of German opposition.

Of course the ECB must have known it was about to ‘disappoint’ the market, and that the euro would strengthen sharply. However, even if the euro does not trend back below, say, 1.06 to the dollar (or hit parity), the fall from the 1.40 level has already done its job in terms of stimulating export competitiveness. If the ECB has decided to step away from the extremes of monetary policy (as we believe), this should be warmly welcomed. The divergent policy stances of the two central banks has been fundamentally problematic, especially given the already-negative nature of ECB overnight and other rates. The Bundesbank message seems to be along the lines of, ‘it’s not OK to debase the euro simply because others have or are doing so, or to provide stimulation when growth in the eurozone is quite good/improving’. Like the rest of us, they can see that it hasn’t worked in Japan, and in many ways neither has it in the US (there, growth only momentarily reached take-off velocity, then stayed low, and the growth that did materialize was very poorly distributed).