ECB, BoC, RBA, Fed: Central Bank Watch 2.0, Predicting More Twist
On Monday, I highlighted that this week was was full of central bank activity, with speeches from officials and rate decisions around the world. So far, the Bank of Canada, the Royal Bank of Australia, and the European Central Bank have all reported, so let us recap the decisions there. Also, many Fed members have been speaking this week, so let us discuss their statements and potential policy actions.
First, I apologize, I had the date wrong on the RBA announcement on Monday, but even so, I did preview it. However, the first central bank to report was the Bank of Canada, which yesterday kept rates firm at 1% but took a very hawkish tone. However, the tone was not as hawkish as it was back at the April meeting, when economists thought that the BoC would raise rates in the next few months to fight rising inflation pressures and a booming economy led by employment growth. The Canadian Dollar rallied on the news and Canadian bonds sold off as yields rose. The continued growth in Canada will be bullish miners (NYSE: GDX), Canadian-exposed countries such as Potash (NYSE: POT), and Canadian-exposed energy companies such as Suncor Energy (NYSE: SU).
The Royal Bank of Australia took a much more dovish stance than its Canadian counterparts, slashing rates for the second straight time. This cut was 25 bps following the 50 bps cut last month. "With modest domestic growth and a weaker and more uncertain international environment, the outlook for inflation afforded scope for a more accommodative stance of monetary policy," Reserve Bank Governor Glenn Stevens said. What investors should read is that China is slowing which is spilling over to Australia through the slow down in end demand for commodities. Watch Australian-exposed miners such as BHP Billiton (NYSE: BHP), Rio Tinto (NYSE: RIO), and Alcoa (NYSE: AA), and the Australian Dollar (NYSE: FXA).
The big event was the ECB interest rate decision this morning, where President Mario Draghi elected to keep rates steady at 1% (which are record lows for the record) and did not announce any new crisis fighting measures. In fact, he seemed to indicate that the ECB will not act until the politicians come up with a scheme to solve the crisis. He has got to be worried seeing the events after the LTRO's: the ECB bought the politicians time, about three months, to come up with a grand plan, a solution, and they did nothing. Draghi has got to fear that the politicians would be unlikely to do anything unless there are severe crisis pressures.
Draghi did hint that inflation expectations are still high, and he expects inflation between 2.3-2.5% this year, which is higher than the ECB's target of 2%. I have a theory that any deflationary pressures that would arise due to bank deleveraging are being exported via the weakness of currency (which is the biggest victim of the crisis so far, in my opinion), and the US and Japan will be the real sufferers of disinflation or outright deflation. Thus, due to this dynamic, the ECB will be all but reluctant to do anything that will be seen causing more inflation.
“This decision was taken by consensus and the discussion was quite complete. It was taken by very broad consensus ... a few members would have preferred to have a rate cut today." He added further, “We are fully aware that the most recent soft data are [on the]downside. That is why you will find several references to downside risk. And we will monitor closely all developments and we stand ready to act."
This week there has also been a lot of Fed member speeches. This morning, Atlanta Fed President and FOMC voting member Dennis Lockhart hinted that more fed easing is possible, following calls for aggressive, expansionary policy last night by the Chicago Fed's Charles Evans, who is an alternate voting member of the FOMC. Today, San Francisco Fed President John Williams (voting member) is set to speak and voting member Janet Yellen does as well. Tomorrow, Bernanke is speaking on the hill, Lockhart is set to speak again, Dallas Fed President Richard Fischer (non-voting member) is speaking on the global economy in California, and Narayana Kocherlakota, Minneapolis Fed President and non-voting member, is set to speak on monetary policy in Minneapolis.
Investors should be watching these speeches tomorrow, as there may be hints of further Fed easing. Full-blown balance sheet expansion via the LSAP is unlikely on June 20, but the Fed could extend Operation Twist. Analysts say that the Fed could only continue Operation Twist for two more months, however if the Fed moves further down the curve, it can twist more. The Fed has been selling its holdings of sub-three year paper and buying long term paper to flatten the yield curve and induce more long-term borrowing for investment in hard assets.
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