Rabobank: Back To Sleep

by Bas van Geffen, senior macro strategist of Rabobank

Back To Sleep

Fixed income markets were in for a bit of a rude awakening after being lulled into a slumber when the Fed’s Jackson Hole conference was moved to an online format last week. After all, if Delta can throw the FOMC’s planned get-together, it might just cause the Committee to reassess its wider impact on the economy. Indeed, expectations of any significant policy announcement at the –virtual– Jackson Hole event are low, and in fact, the market appears have added some speculation that the taper announcement could be delayed even further.

That sleep was rudely interrupted as evidenced by the sell-off in European government bonds yesterday: German 10y yields rising 5 bps and the Italian equivalent even by 9 bps on the back of ECB policymakers De Guindos and Lane. De Guindos’ comments were widely interpreted as hawkish -at least compared to his usual stance- as he noted that the data so far point to a solid Q3. He concluded that the ECB may upgrade its economic projections, and that if the economy normalises, policy should follow. Of course, he probably primarily had PEPP in mind, with the calibration of the unofficial target pace of Q4 purchases up for debate in September. Nonetheless, amidst otherwise quiet markets -with ECB buying also still on summer schedule- that may have startled some slumbering traders.

The market was less unanimous about Chief Economist Lane’s comments. At face value, Lane seemed to strike his usual dovish tone, but a case could also be made for a more hawkish read. For example, being asked when the ‘crisis phase’ (and thus PEPP) are over, he replied “the crisis phase lasts while the downside risk is substantial”, which should be seen in the context of the ECB’s current assessment that risks to the economic outlook are “broadly balanced”. Of course, he did add that post-PEPP, the regular purchases would continue to add stimulus. The market being awakened by both ECB officials is somewhat ironic, considering that Lane specifically hummed the lullaby that the ECB would act if a US taper tantrum would cause spill-overs into European markets.

As an aside, these discussions about tapering in the US and the future for (or after) PEPP in the Eurozone will once again kindle the debate between stock and flow effects of quantitative easing. Policymakers are often keen to stress the former, noting that the central bank’s built-up portfolio effect remains a powerful force. Traders, however, tend to focus on the flow effects of new buying. Perhaps aware of this, Mr. Lane addressed the flow effect yesterday. He noted yesterday that “you cannot think about the volume of the APP independently of the volume of net bond supply. The relatively high fiscal deficits that we saw last year and this year will not be lasting in the coming years”. He’s not wrong. I would defer to the extensive work my Rates Strategy colleagues have done on the topic of net-net supply (i.e. issuance minus redemptions and ECB purchases). And there’s certainly an argument to be made for Lane speaking the market’s language.

However, these comments are clearly at odds with the mantra that the ECB does not finance deficits. We, too, have in the past drawn comparisons between the impact of Covid-fighting measures on government’s issuance and deficits on one hand, and the ECB’s decisions to enlarge the PEPP envelope on the other.