September 12, 2016    3 minute read

The Fed And The ECB Signalled The End Of Summer Trading

The Calm Is Over    September 12, 2016    3 minute read

The Fed And The ECB Signalled The End Of Summer Trading

German ten-year government bond yields rose to 0.02% on Friday and they are up to 0.04% on Monday. This was the first time the benchmark was in positive territory since Britain’s June vote to leave the European Union. The US government bonds yields also rose to their highest levels since June, sending their benchmark to 1.688% on Monday as compared with 1.671% on Friday and 1.614% the day before. Most of this rapid change can be attributed to the continued fallout from Thursday’s European Central Bank meeting and increased speculation that the Fed could raise interest rates this month.

Draghi Set It In Motion

The moves mainly began after ECB’a President Mario Draghi said on Thursday that the central bank had not discussed fresh stimulus at its meeting and praised the effectiveness of the bank’s existing policy, which includes negative interest rates and $89.9bn of monthly bond purchases.

This decision to continue with its current policy and not to add any new stimulus shows that the central banks may be approaching the limits of what they can achieve without any support from governments.

If the ECB should reach their limits, they will have mainly two options. They will either have to persuade governments to increase spending or they will have to change the rules for the current quantitative easing program, which say that the ECB cannot buy more than 33% of most bond issues, or any bonds yielding less than minus 0.4%.

Draghi also said that the ECB has not discussed any radical new policy measures, such as buying stocks or providing helicopter money. He pointed out that the growth forecast has slightly decreased because of the external turbulence, including Brexit, but mentioned that “for the time being, the changes are not so substantial as to warrant a decision to act.”

The Fed Is Set To Make A Move

The comments from Federal Reserve Bank of Boston President Eric Rosengren, who has long been viewed as dovish, added to the selling pressure on bonds. He said, in an interview:

“If we want to ensure that we remain at full employment, gradual tightening is likely to be appropriate.”

The market interpreted his statement as a hawkish sign. He, however, did not specifically say whether he supports raising interest rates in September or not.

Three other Fed officials are scheduled to speak on Monday, after which the central bank enters a self-imposed blackout period before its September meeting. The most closely watched speech will be delivered by Fed Governor Lael Brainard, who has been seen as a leading opponent of rate hikes for much of the past year. Any hawkish remark in her speech may stimulate volatility in financial markets, where the current probability of a rate increase is 21% as compared to 24% on Friday and 18% the day before, according to the Federal-funds futures provided by CME.

All of this points to the enormous sensitivity of bond markets to even the slightest deviation in central banks policies from what the market expects. And event though one will have to wait and see if this trend in bond prices continues, one thing is for sure: the summer calm is over.

Get articles like this straight to your inbox each morning with our Breakfast Briefing. Sign up by clicking here!

Log in with your details

or    

Forgot your details?

Create Account

Send this to a friend