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Central differences of central banks

The G10 central banks vary on their policy stances, with the RBNZ at the hawkish end, the BoJ at the dovish end, and all the rest somewhere in-between. 

The three banks to watch in April will be the Federal Reserve (Fed), the European Central Bank (ECB) and the Reserve Bank of Australia (RBA).

The Fed

The Fed has given itself two main focuses for QE, unemployment and inflation, but you can’t look past growth as well.

This two-pronged mantra of the Fed has probably been skewed towards unemployment. However, with jobless claims at the lowest levels since November last year, expectations heading into non-farm payrolls Friday and a week of employment data are that good prints will put even more pressure on the Fed to move to a neutral stance.

Inflation, however, is one area that QE has really yet to impact. Confidence is returning to the US market after a stronger Q4 GDP print and the US economy grew at 2.6% on an annualised basis, but this is still below historical trend growth and consensus.

Chicago Fed President Charles Evans reiterated what was seen from Janet Yellen; stating that rates will rise ‘at least six months’ after the asset purchase program ends. As a known dove this is an interesting development, but Evans believes rates are likely to rise in the second half of next year. However, he would prefer if it was later than this as he believes inflation remains too low. He also wants to see growth at 3% for the rest of 2014 and believes the Fed funds rate is more likely to be around 1.25% at the end of CY16, which is 100 basis points less than the projections released last week and only 25 basis points higher than the forecasted rate at the end of CY15.

However, in my opinion the movement in economic projections - which has seen the rises in the Fed funds rate being brought forward and up in 2015 and 2016 - will be a game-changer in the yield-play trade. The prospect of a breakdown in high-yielding equities for the higher yielding, and what will be cheaper US treasuries, is coming. This will see a breakdown in the carry trade and the repatriation of USDs that have been globally dispersed as hot money that entered the market from QE returns – I’ll be watching this space closely. This means that on a longer-term fundamental perspective we will see USD strength, Fed fund rate strength and the unwinding of the US carry trade.

The ECB

There are two central banks moving to the dovish end of the spectrum; one is the Bank of Canada (BoC) the other is the ECB. ECB President Mario Draghi stated that he expects ‘monetary policy to regain influence over the economic cycle, and our accommodative stance to support a gradual closing of the output gap in the coming years’.

It has been the language from Jens Weidmann, the head of Bundesbank and governing council member on the ECB, that sparked the most interest by suggesting QE ‘was not out of the question’. This huge change in stance for the hawkish member is a sign that the ECB is moving towards the dovish side. 

However, I see these statements as something central bankers are now doing as part of their arsenal to high currencies – this appears to be jawboning. The statements did see the EUR finally contract after a three-day rally, but it remains a headache. A EUR above $1.37 starts to make the zone uncompetitive and increases the political pressure on domestic economies; at $1.38 the fear is deflation.

Spain, France and Italy have all publicly complained about the EUR at this level in the past three years. With Spain and Italy still struggling under the pressure of high unemployment, it is understandable why stimulus expectations are growing and why Mario Draghi is likely to continue with his mantra of ‘whatever it takes’. But this is unlikely to eventuate in April as PMI data is strengthening, peripheral bonds markets are at the lowest levels since the euro-crisis began and private lenders are no longer taking up the ECB’s LTROs. The EUR looks like it’s in for some finessing.

The RBA

Although most people now describe the RBA as neutral, having seen the removal of the easing bias in the cash rate statement in February, it was expected that the bank would monitor the rise of the AUD. But Governor Glenn Stevens has now taken the RBA squarely between neutral and hawkish.

In his recent address he stated that there are encouraging early signs of a handover between the mining space and domestic consumption, and he believes that the Australian economy may strengthen later this year.

He moderated this bullish outlook by saying, ‘this outlook is, obviously, a balance between  the largest negative force of declining mining investment and the likely pick-up in some other areas of demand, helped by very low interest rates’.

The reference to low interest rates has certainly had a profound effect on market perceptions of a rate rise. The AUD is now at four-and-a-half month highs against the USD, EUR and GBP.

This is an interesting development as the bank had been actively jawboning the AUD lower over the past year. Stevens did allude to the fact that the lower the AUD over the past six months has helped the Australian economy, along with global macro conditions. But unlike previous months where the AUD and its historically high value has received a large amount of attention from Stevens, he no longer mentions it as a concern - jawboning appears over, after seeing the RBA move from dovish to a more hawkish stance.

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