Macro Wrap-Up

What They Say, Not What They Do

Topics - Macroeconomics

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What They Say, Not What They Do

In the past two weeks we’ve talked about the prospects for both monetary and fiscal stimulus. In these discussions, we generally assume that stimulus will be positive for risky assets such as stocks. The economic logic behind this assumption is that stimulus will improve short-term growth, which in turn leads to higher earnings and a lower risk of imminent recession. Sadly, the market doesn’t always agree with our analysis. Last week, for example, the European Central Bank (ECB) was surprisingly dovish at its meeting. It announced a new set of targeted longer-term refinancing operations (TLTROs); said that it would continue reinvestment of maturing QE bonds for an extended period; and promised rates would be on hold until at least the end of the year. 1 1 Close European Central Bank: “Introductory statement to the press conference,” 3/7/19. , 2 2 Close This week, the ECB also announced that the euro short-term rate (ESTER) will now be known as €STR.  This comes almost five years after Kesha dropped the $ from her name.  It was about as stimulative a meeting as possible. Both the euro and bund yields fell, but the Euro Stoxx 50 index ended the day a little lower. The initial reaction wasn’t a fluke: the Euro Stoxx 50 index was down again the next day.

Some folks claimed the reaction was “buy the rumor sell the news,” in which traders positioned in anticipation of the announcement and then unwound their trades after it was made. This easy explanation does not explain the dissonance in currencies, bonds, and equities. Also, the ECB dovishness seemed to surprise even the most optimistic of forecasters so it’s unlikely everyone was positioned for it. 3 3 Close If you consider calling for dovishness being optimistic. You could argue that if short-term traders were positioned for a dovish ECB, then they would unwind no matter how dovish the announcement was.  Any short-term market reaction can be dismissed as noise, but this time it appears to be something more. The cause seems to be the discussion on outlook during the ECB press conference. In addition to announcing new measures, the ECB “substantially” cut its forecasts for real GDP in 2019. 4 4 Close European Central Bank: “Introductory statement to the press conference,” 3/7/19.   ECB President Mario Draghi sounded very cautious in his evaluation of Europe’s prospects because of concerns about protectionism and external pressures.

This was a material change for Draghi and the ECB. European data had been weak for much of 2018, but the ECB had maintained a cautious optimism. They acknowledged downside risks, but remained sanguine on the outlook. As recently as December, Draghi said that, “domestic demand, also backed by our accommodative monetary policy stance, continues to underpin the economic expansion in the euro area.” 5 5 Close European Central Bank: “Introductory statement to the press conference,” 12/13/18.   January’s statement was more reticent, but still didn’t have last week’s downbeat tone. Markets may have been reacting more to what the ECB was saying rather than what it was doing. The pessimistic outlook may explain why German yields and the euro were down without a positive reaction in the Euro Stoxx 50 index. 

This type of reaction is fairly common. Markets seem to attribute a combination of omniscience and impotence to authorities. Some investors think that central bankers and government officials have special knowledge of the economy, but these same investors are skeptical of the tools that officials have to act on it. They think that if the ECB is saying the economy is going to be weak, then it will probably be weak. This view is not completely unfounded. Central banks have enormous teams of economists equipped with sophisticated forecasting models. In some cases, officials have better information because they get to see economic data a few days early. 6 6 Close Recall President Trump’s tweet on the employment report hinting that it would be good. See: Wall Street Journal: “Trump Tweeted About Jobs Report Before Release,” 6/1/18. We have argued that revisions of forecasts in general contain valuable signals for market participants. Maybe the forecast-followers have a point. 

Unfortunately, history is not on their side.  Knowing the data a few days in advance has not given central banks a big edge in medium-term forecasting. 7 7 Close Recall President Trump’s tweet on the employment report hinting that it would be good. See: Wall Street Journal: “Trump Tweeted About Jobs Report Before Release,” 6/1/18. While their track records are not as bad as some of their critics assert, they have not shown exceptional clairvoyance. In particular, they have missed some major turning points. For example, in August of 2008, the Fed claimed that “easing of monetary policy …should help to promote moderate economic growth.” 8 8 Close Federal Reserve: “FOMC Statement,” 8/5/08. , 9 9 Close That sounds pretty similar to what the ECB said last year, but I wouldn’t get too worried. Incidentally, one Fed President voted for a rate hike in August of 2008. His name was Richard Fisher. The Fed was more concerned at the meeting in September of 2008, but by then so was everyone else in the world. The ECB showed a similar lack of urgency prior to the sovereign crisis a few years later. 10 10 Close The ECB reacted aggressively later in the crisis, and many credit Draghi for his actions.  Forecasting is difficult even for large organizations with deep resources.

This doesn’t mean we think that the official forecasts should be dismissed, just that they shouldn’t be weighted more heavily than their private sector counterparts. ECB forecasts belong in the consensus numbers. The only difference is that official forecasts have more of an impact on future policy and can be used in gauging central banks and government’s intentions for action. Their actions matter more than their ability to predict the future. Any change in monetary policy should be more material than a change in forecasts.

The ECB’s tools are limited, so it’s understandable that investors might think its actions don’t matter much. ECB members seem to think that rates are at or near the effective lower bound. There is little appetite for additional credit easing via QE. The best that the ECB can do is to extend the TLTROs and add some guidance on rates and its balance sheet. It might not seem like much, but it’s a lot more important than the information from the change in forecasts. It should keep short rates anchored and remove any uncertainty for banks. In the past, the ECB has shown itself to be very resourceful in finding ways to stimulate the economy. And it’s not like folks thought the European economy was operating at potential prior to the ECB meeting. At least they shouldn’t have.

FOMC Meeting (Wednesday)

Since the start of the year, Fed guidance has grown significantly more dovish. The January FOMC statement dropped previous references to further hikes, and Chair Powell announced that “crosscurrents” such as slower global growth and tighter financial conditions “warrant a patient, wait-and-see approach regarding future policy changes.” 11 11 Close Transcript of Chairman Powell’s Press Conference, 1/30/19.  Fixed income markets have responded to the Fed’s tone change, with Fed Funds futures now pricing a bias towards rate cuts over the next year. With respect to the March FOMC meeting, market participants will be watching to see if the dovish trend in guidance continues. In particular, the updated “dot plot” may indicate how many meeting participants still expect rate hikes to resume at some point in 2019 or 2020. If there appears to be a strong consensus around unchanged policy, or if a meaningful number of officials project rate cuts within the forecast horizon, it could lead to gains in fixed income and weakness in the dollar.

Norway Central Bank Meeting (Thursday)
The Norwegian central bank (the Norges Bank) appears likely to raise interest rates at its upcoming policy meeting, delivering on guidance for a March hike from its January statement. While growth in Norway’s trading partners has slowed down, domestic activity has remained strong. “Mainland” GDP growth (which excludes activity in the volatile offshore oil sector) for Q4 was stronger than Norges Bank’s December forecast, and recently released core inflation data was higher as well. With growth and inflation on firm footing and exceeding the central bank’s expectations, market focus will go beyond the likely hike to the policy bias following the rate adjustment. A key question is whether the central bank will moderate its hawkish tone given the broad-based economic slowdown in Europe or will continue to focus on domestic dynamics to determine policy. 

Eurozone PMIs (Friday)
At its latest meeting, the European Central Bank (ECB) announced easing measures via more dovish forward guidance and the announcement of a new series of targeted longer-term refinancing operations (TLTROs). However, even with these announcements it stated it viewed the risks to growth in the euro area as “still tilted to the downside.” 12 12 Close European Central Bank: “Introductory statement to the press conference,” 3/7/19. The ECB’s view of growth in the euro area seems to have shifted from a transitory deceleration to a more deeply entrenched slowdown requiring policy action. Markets will watch survey data closely for early signs of whether or not the ECB’s action will boost sentiment and ultimately drive improvement in hard data. This week’s preliminary March PMI data will be one of the first reads on sentiment after the ECB’s meeting. While it is unlikely a sharp turn around will be seen this soon, any signs of green shoots after the weaker euro area data of the past few months would likely be taken positively by markets. A downside surprise could exacerbate concerns around the health of the European economy.

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