- FOMC minutes reveal doves’ concern that changing guidance could send the wrong signal…
- …while they also point to risks on inflation, further dollar strength and global growth
- ECB’s Constancio talks about trillion euro universe for asset purchases, but actual likely lower
Debate on forward guidance heats up
The minutes of the FOMC’s September meeting showed that the forward guidance on interest rates was hotly debated. A significant number of officials appeared uncomfortable with the forward guidance, which maintained that interest rate would remain on hold for a “considerable time” after the asset programme ends as it implied a commitment to keep rates low. FOMC member Plosser, who voted against the guidance, was of the view that the calendar time should be replaced by language that indicates how monetary policy will respond to incoming data. More importantly, Mr Plosser added that the lack of clarity risked unnecessary and disruptive volatility in markets if the Committee decided to reduce accommodation sooner than later. On the other side, the doves argued that changing the guidance could be misinterpreted as a signal of a fundamental shift in the stance of policy. During the press conference, after the FOMC meeting in September, Chair Yellen explained that the term “considerable time” was ultimately maintained given that significant slack remained in the labour market. Nevertheless, she added that the evolving economic outlook would dictate the policy stance. As such, she asserted that a rate hike is data dependent and not calendar dependent. Unemployment has fallen further since the FOMC.
More dovish members point to risks
Meanwhile the more dovish members underlined a number of risks. Several members expressed concern that inflation might persist below the FOMC’s objective ‘for some time’ though the general view was that inflation would move back to target over the coming years. Since the meeting the decline in oil prices has continued, which could give the doves some ammunition. The more dovish members also expressed concerns about a strong US dollar and weak global growth. This suggests that inflation will be a topic of attention in the next FOMC meeting, particularly among the more dovish members. Having said that, the midpoint view of FOMC members in September was that rates would need to rise faster in 2015 than thought before. Our central view is that interest rates will likely go up around the middle of next year, and will rise by more than financial markets are currently pricing in.
ECB’s Constancio talks about trillion euro universe
ECB Vice President Vitor Constancio provided some more details about the central bank’s upcoming asset purchase programmes. In a speech in Frankfurt, he said that the stock of covered bonds totalled EUR 1.2 trillion, while the existing stock of ABS totalled EUR 690 billion. Given the restrictions for purchases set out following the Governing Council meeting (relating to credit quality and complexity), Mr Constancio noted that the potential universe for asset purchased was around EUR 1 trillion. This reflected that EUR 600bn of covered bonds and EUR 400bn of ABS qualified as purchasable assets. He noted that the ECB would buy only senior ABS tranches, but would consider buying mezzanine tranches only if they benefit from an appropriate government guarantee. He said that such guarantees would allow ‘banks to establish a market-based funding mechanism for SME loans’. This suggests that the ECB’s potential universe could grow significantly in coming quarters, in the case of government guarantees. However, a number of countries have ruled this out, so the risk is that the programme is to a large extent limited to the potential universe of existing assets set out by the Vice President. In addition, he noted that the ECB is ‘aware that the amounts that it will be able to buy will be lower than the theoretical amount’ as ‘holders…must be willing to sell’. The exact proportion of the assets the ECB would be able, but also willing to buy (given that it would not want to play a too dominant role in the market) is of course uncertain. Our base case is that the combined total covered bond and ABS purchases will be around EUR 150bn.