Markets have been pricing in an early lift-off of the ECB’s deposit rate. The ECB argues that, considering its inflation outlook, this is not warranted. This difference in view could reflect a loss of central bank credibility. More likely is that market participants and the ECB disagree on the inflation outlook. Another explanation is that investors focus on the distribution of possible inflation outcomes and are concerned about the risks of inflation surprising to the upside.
Although the significant increase in inflation in most advanced economies is expected to be transitory, it is necessary to focus on the potential consequences of inflation staying temporarily high for longer. Companies that hitherto have been reluctant to raise prices might do so after all, higher inflation could weigh on spending but also cause wage demands to grow, inflation expectations could drift higher, the market sensitivity to growth and inflation surprises would increase and there could be fears about a change in the reaction function of the central bank. In the coming months, investors and central banks will scrutinise data in parallel, but the former will react more quickly should inflation stay high.
Successful market timing between equities and cash requires high skill levels. Very low official interest rates, through their impact on market rates, create a disincentive for doing market timing because they increase the break-even skill level. The same applies for quantitative easing. These considerations are important from a financial stability perspective. Growing investor reluctance to do market timing will probably lead to a decline in equity market volatility and an increase in equity valuations. The former provides a false sense of safety whereas the latter increases the sensitivity to negative news and hence increases the riskiness.
In the early phase of QE, financial markets perceive central bank forward guidance on asset purchases and on policy rates to be closely linked. This generates a mutual reinforcement of both instruments. At a later stage, there may be mounting concern that the signalling works in the other direction as well. Scaling back asset purchases could be interpreted as a signal that a rate hike will follow soon once the net purchases have ended. In the US, Jerome Powell has been very clear that tapering would not signal a change in the outlook for the federal funds rate. In the Eurozone, both types of guidance are explicitly linked. This may complicate the scaling back of asset purchases in view of the impact on rate expectations
Close to 2/3 of public debt in Central America* is owed to non-residents. Costa Rica is the least dependent on external funding. Nicaragua and Panama are the most dependent – however with diametrically opposed creditor profiles. The former’s external commitments are due to official creditors (e.g. multilaterals or bilateral creditors such as Taiwan) while ¾ of the latter’s are owed to private creditors (primary bondholders) – a share comparable to Latin America’s third largest sovereign bond issuer in 2020 – the Dominican Republic. In a context of increasing debt burdens (+12 percentage points across the region in 2020), a high dependence on external funding is a source of financial vulnerability – especially for those countries whose external debt is mostly held by private creditors (e
Foreign investors have significantly increased their purchases of Chinese local bonds since Q2 2020, targeting sovereign papers particularly. In fact, foreigners are currently holding only 3% of the total stock of Chinese local bonds, but 10% of the total stock of central government papers. Foreign investors’ holdings of local bonds increased by RMB 120 bn per month in average from April 2020 to February 2021, against +RMB41 bn in the previous twelve months. This dynamic suddenly stopped last March. It should resume in the short term, yet without returning to the 2020 levels. Several factors account for these recent foreign investment flows: the increase in local yields and the widening spreads with US Treasury yields (yields on Chinese ten-year sovereign bonds rose from 2
In 2020, the Brazilian main equity index – the B3 Ibovespa – recovered swiftly from the commotion caused by the pandemic. After hitting record highs in January, the index lost 50% of its value in March before ending the year on a 3% gain. The year also ended with a record number of initial public offerings (26 IPOs and nearly USD 8 bn in funds raised – the highest level since 2007). The proceeds of these offerings were used to acquire assets or equity interests, cover working capital needs, pay down debt and invest in infrastructure – in that order. Global factors have facilitated this rapid bounce back. Liquidity injections and record low interest rates across the globe in addition to vaccines development helped spur an increase in risk appetite
In first-half 2020, a massive sell-off of treasury bills by non-resident investors (-USD 12 bn starting in March 2020), combined with a decline in tourism revenues, albeit to a lesser extent, triggered a drop-off in the central bank’s foreign reserves. In May, foreign reserves declined by USD 9 bn to USD 36 bn. At the same time, the net external position of commercial banks swung from a surplus of USD 7.2 bn to a deficit of USD 5.4 bn. At the end of May, foreign currency liquidity in the banking system was still at an acceptable level, since official reserves still accounted for 5.8 months of imports of goods and services
The US mortgage market – the epicentre of the 2007-2008 financial crisis – has yet to be reformed. Nearly half of the USD 10,000 billion in housing loans are guaranteed by the Federal government via two private agencies (GSE), Fannie Mae and Freddie Mac, which were placed under FHFA conservatorship after they were bailed out in 2008. In recent weeks, there have been growing rumours that the FHFA is seeking to hasten the end of its conservatorship of the two agencies. Accelerating this process risks restricting household access to mortgage loans by prematurely ending the GSE Patch
Although the second wave of the epidemic appears to have peaked in mid-November, the economic outlook, particularly for the labour market, is worrying in Greece as it is in other countries. The consumer unemployment expectations index, published by the European Commission, is deteriorating again, and posted in November its worst reading since August 2013. The hard unemployment data from the Greek statistical service are traditionally lagging: the latest data are for August. Despite managing relatively well the epidemic, the Greek economy has taken a sizeable hit due to the steep decline in tourism, a slowdown that could extend beyond the epidemic phase and hold back the recovery in 2021
The Covid-19 pandemic has led to the most severe recession in Germany’s post-war history. The sudden drop in revenues in combination with only partly adjustable costs has led to a fast depletion of firms’ cash buffers. Business felt compelled to reduce inventories, cancel orders and defer investment projects. This had the effect of deepening the recession. It might be tempting to think that investment could quickly regain traction again, as it did following the Great Recession in 2008-09. This sounds too optimistic. European Investment Bank (EIB) researchers estimate that the European corporate sector could have lost revenue between 13% and 24% of GDP because of the Covid-19 pandemic[1]
Activity indicators for July reflected the continued recovery of the Chinese economy. Real GDP growth already rebounded to 3.2% year-on-year in Q2 2020, up from a 6.8% contraction in Q1. The acceleration in investment growth since March has been driven mainly by public infrastructure projects, the construction and the real estate sectors, which have been supported by the government’s stimulus measures. Manufacturing investment has recovered more slowly, held back by the financial difficulties of corporates, particularly amongst SMEs. In the second half of 2020, investment in public infrastructure is set to remain strong, helped by continued expansionary fiscal policy
To cope with the collapse in their revenues during lockdown, French non-financial corporations (NFCs) raised record funding flows. These totalled close to EUR 208 billion year-on-year net of repayments at end-June 2020, or 2.5 times the annual average recorded between 2017 and 2019 (EUR 83 billion). The growth in funding flows stemmed chiefly from bank loans (EUR 118.5 billion at 30 June, including some EUR 106 billion in PGE state-guaranteed loans since 25 March 2020) and also from net issues of debt securities (EUR 89 billion). NFCs’ deposits posted a matching increase (EUR 173.4 billion), and so the annual increase in debt net of deposits remained within the range seen since 2012
The Covid-19 pandemic has caused a jump in most of our uncertainty indicators. The media coverage based indicator is now at a record high. After stabilising at a high level, uncertainty of German companies has increased further whereas it has seen a big jump for US businesses. The behaviour of geopolitical risk is an exception...
