Compared to the Federal Reserve policy, the ECB monetary policy trends have been less market attention, one is due to the total amount of liquidity released in the past the ECB is relatively conservative, the second is the European economic cycle is relatively lagging behind the United States, the ECB monetary policy is difficult to have forward-looking significance. However, at a time when the impact of the epidemic on the global economy lingers, the impact of the ECB monetary policy may be overlooked by the market.
Why the current need to focus on the ECB monetary policy?
The immediate reason why the market needs to keep an eye on changes in ECB policy alongside the Fed’s policy developments is that we believe that the unexpected downside in U.S. bond long yields in early April and July this year was largely related to the ECB’s accelerated expansion at these two points in time accordingly (the same scenario was seen in 2015-2017).
While there are multiple explanations in the market for the decline in U.S. bond yields, in terms of timing, we believe that it may be more correlated with the ECB’s accelerated liquidity release. Other factors are less well aligned in terms of timing, such as.
1) The topping out of economic fundamentals and the recurrence of the Delta epidemic: in terms of timing more in May and June.
2) Short-term liquidity from the fiscal TGA “flood”: the Fed’s liquidity recovery through reverse repos is more of a transfer of different accounts on the liability side of the Fed’s balance sheet.
(3) the fiscal debt ceiling led to a significant decline in the supply of debt issuance: indeed, the supply of fiscal debt issuance fell in April and May, but this trend began in September 2020 at the earliest.
In terms of the size of euro-denominated assets, the ECB accelerated its expansion in the last week of March and the last week of June, and U.S. bond yields saw an acceleration downward at the corresponding points. As of July 14, 2021, the Fed expanded by $622.3 billion relative to March 10, the Bank of Japan shrank by $820.5 billion over the same period, while the ECB increased its expansion by $929.7 billion over the same period, close to $1 trillion expansion scale, making the ECB the “front runner” in the expansion of developed central banks during this epidemic. As of July 14, the total asset size of major developed central banks are: the Federal Reserve 8.3 trillion U.S. dollars, the ECB 9.4 trillion U.S. dollars, the Bank of Japan 5.8 trillion U.S. dollars, the Bank of England 1.2 trillion U.S. dollars. Although the data on the proportion of foreign holdings of U.S. debt has declined relative to previous years (from 47% at the end of 2015 to about 34% at the end of last year), I am afraid that the actual situation of increased allocation of U.S. debt by funds pried by the ECB release is difficult to be fully accounted for in the data.
Taken together, we believe that the unexpected decline in the 10-year yield of U.S. debt in April and July stems more from: the ECB’s increased release of liquidity, while the supply of U.S. fiscal debt issuance in April, May and July there was a significant decline caused by.
If the U.S. Treasury TGA “flooding” and reduced supply of debt issuance is the main reason for the sharp decline in U.S. bond yields in the past six months, along with the resumption of the U.S. Treasury financing program in August and September, these factors inhibiting U.S. bond rates weakened, may bring U.S. bond rates rebound. However, if the ECB’s accelerated expansion is the dominant reason behind it, the timing of the sharp upward movement in U.S. bond rates could be pushed back again to when the ECB’s liquidity margins ebb (expected around March 2022).
What’s new in ECB monetary policy this year?
Since the epidemic, the ECB’s monetary policy has been dominated by quantitative tools. Since the ECB implemented negative interest rates, adjustments to the benchmark interest rate have been very cautious. The ECB’s current monetary policy thinking has shifted from price adjustment to quantity adjustment, with the main tools including long-term refinancing operations (LTROs), non-targeted emergency long-term refinancing operations (PELTROs), QE asset purchases (such as PSPP, PEPP) and other quantitative tools.
The ECB has been increasing its efforts in asset purchases since this year. For the ECB, the current form of asset purchases are mainly divided into two, one is the regular QE, one is for the epidemic QE. from March last year after the outbreak of the epidemic in Europe, the ECB increased the amount of QE to 120 billion euros a year, the monthly scale of bond purchases from 20 billion euros / month to 32 billion euros / month. At the latest interest rate meeting on July 22 this year, the ECB statement said that it will continue the monthly bond purchase scale of 20 billion for a long time, which may end shortly before the next interest rate hike, which means that the current regular bond purchase program will be maintained until at least after 2022. On the other hand, the emergency asset purchase program (PEPP) for the epidemic is the main debt purchase tool at the moment, and the ECB increased the PEPP purchase size by 500 billion to a total size of 1.85 trillion euros at the end of last year, extending the PEPP debt purchase maturity to the end of March 2022. In the interest rate meetings in March and June this year, the ECB proposed to accelerate the pace of PEPP purchases (which will be significantly higher than in previous months of this year). Combined with the flexibility of the PEPP, the ECB’s subsequent bond purchases may further increase in scale.
The ECB revised its inflation target for the first time in two decades to a “symmetric target of 2% in the medium term.” On July 8, 2021, the ECB revised its medium-term inflation target from “below but close to 2%” to “symmetric target of 2%” in a new review of its policy strategy. The ECB revised its medium-term inflation target from “below but close to 2%” to “a symmetric target of 2%” and allowed inflation to be moderately above 2% for a period of time if necessary. This shift is a step towards dovishness, expressing patience for a pickup in inflation. Similar to the Fed, the ECB sees the rise in inflation as temporary, although its emphasis on weak wages and a medium-term inflation outlook well below the ECB’s target means that the ECB will be easing for a longer period than the Fed.
The timing of the ECB’s monetary normalization is expected to lag significantly behind the Fed. From the actual economic and inflation recovery status, the European economy has a long way to go to return to the normal economy, and the epidemic in Europe is more serious than the United States, the overall inoculation progress is slower than the United States, therefore, we expect the recovery of the European economy and the timing of monetary normalization will lag behind the Federal Reserve. The ECB continued to state at the July rate meeting that the pace of PEPP’s bond purchases will accelerate significantly in the coming quarter. Given the advantages of PEPP in all aspects, PEPP will probably be the ECB’s main tool to deal with economic shocks in the coming period, while in the framework of the “medium-term 2% symmetric target”, the ECB’s easing exit rhythm may be slower than previously expected.
The difference between the ECB expansion and the Fed expansion and its impact?
The ECB’s expansion also corresponds to an increase in overall liquidity. However, unlike the Fed’s expansion, the ECB’s release of liquidity means that funds flow out of Europe and into the U.S. dollar, and the U.S. dollar exchange rate is strong; the additional liquidity increases the demand for U.S. bond allocation and suppresses the upside of U.S. bond yields. It is expected that the ECB’s expansion will partially offset the Fed Tapering (tapering QE) on global liquidity withdrawal, marginal delay in the trend of liquidity tightening. If the ECB’s accelerated expansion is the dominant reason for the downward movement of U.S. bond yields in the last six months, the timing of a significant upward movement in future U.S. bond rates may be pushed back again to when the ECB’s liquidity recedes on a marginal basis (expected around March 2022), and our judgment on the timing of the upward movement of U.S. bond yields to 1.8% is pushed back by about six months accordingly.
From the data of eurozone portfolio capital allocation flow, since the ECB accelerated asset purchases at the end of last year, eurozone portfolio capital began to gradually flow out of the eurozone, initially more funds were allocated in the equity portfolio, but the outflow of funds allocated to long bonds increased after March. As of the latest May 2021 single-month data show that the portfolio allocation of long bonds out of the euro area of about 87.3 billion euros, compared to Q1 showed accelerated outflow from the euro area.
Referring to the 2014 Central European Central Bank to start the asset purchase program APP (Asset Purchase Programme, that is, the European version of QE), the eurozone portfolio allocation funds also appeared in a significant outflow of the eurozone scenario. At that time, the Fed was in the middle of a rate hike and tightening cycle, and the global liquidity easing in 2015-2017 came more from the ECB’s expansion, and U.S. bond yields were also largely influenced by the additional funds from Europe, with yields moving downward. Compared to 2015-2017, current outflows from Europe have not only increased long bond investments, but also increased equity portfolio allocations at the same time.
The slow global supply chain repair can bring about a longer than expected inflation upturn, leading to increased policy divergence within central banks and thus monetary policy uncertainty; the continued rebound of the epidemic leads to tighter blockade measures, thus dampening the economic recovery trend.