By Amit Pabari
During the COVID-19 pandemic, central banks flew their jet and came up with an option of “Helicopter money” to take charge of the dwindling economic situation due to lockdown. It is nothing but an unconventional monetary policy aimed at bringing a flagging economy back on track. Using this tool, they flooded the market with ample liquidity to pull it out of a dip slump. That apart, vaccination drives since the start of 2021 have worked quite well for reopening. The demand returned, but the supply disruption has been observed. This led to soaring commodity prices and so inflation expectations across the globe.
Under the given scenario, which central bank will lift off its easing stance? Let’s read their minds one by one
1. Federal Reserve: The market participants have a lot of expectations from 16th June Fed monetary policy. Two key factors which Fed focuses on are inflation and job numbers. The core PCE (Personal Consumption Expenditures) to be the best gauge of inflation rose faster than expected at 3.1% in April as price pressures built in the rapidly expanding U.S. economy. But the job report is still not upto the mark that fed considers for tapering. Apart from this, an interesting observation in the fed’s balance sheet suggests something is cooking. Under QE, fed is buying $120 billion securities & bonds and flowing liquidity in the market. But since April, Fed has come up with Overnight Reverse Repo-ON RRP (Fed borrows from US commercial banks to control excess liquidity) and pulled out $8.8 trillion from the market. As liquidity stopped increasing, risk-on asset-equity stopped performing like what it was before April.
This can be compared with the 2013 taper tantrum case when along with QE, the fed had done the same ON RRP and then we had seen the announcement of tapering. Overall, fed is expected to announce tapering, either in June or in August’s Jackson Hole meeting or finally in the September meeting. The higher vaccination rate, Biden’s infra spending, and stronger economic data will force fed to talk on tapering very soon. Hence, we expect that Fed would be the first central bank (Like 2013) to go hawkish.
2. Bank of England: The UK which has undoubtedly carried their vaccination program extremely well, and has good chances of reopening on June 21; just before BoE revisits their policy on June 24. However, the Indian variant or so-called Delta variant possesses a risk over its potential to undo some of the country’s hard-won progress toward reopening. On the data front, retail sales and the manufacturing number have been above estimates, but growth figures need to pick up well in the upcoming time. In the last meet, BoE had already announced to slow down their bond-buying to £3.4bn a week between May and August, from the current pace of £4.4bn, but made it clear that this should not be taken as a change in the stance. One MPC member was already turned in favor of tapering, and probably many will join him in the upcoming meet if the economy outperforms and inflation persists above 2% levels. The BoE stands just behind Fed to turn hawkish and do tapering.
3. European Central Bank: The ECB monetary policy which is scheduled to meet this week on 10th June will be a non-event but very exciting. Because since the April meeting, the European countries have done a remarkable job in rolling out the vaccination drive. That has helped them to think over reopening like the US. The economic outlook has brightened further and inflation forecasts are expected to revise higher. Another interesting element will be the first official quarterly assessment of financing conditions in the Eurozone will be presented. The German bund yield has been in negative territory over the last 2 years, was seen recovering almost 50 bps from 2021 low of -0.60 as recovery is discounting in yield. The ECB could avoid the discussion on tapering, but for that strong reasoning needs to be presented or else doubts on the sustainability of the economy and euro will come under question. Compared to Fed and BoE, ECB still lags in terms of going for tapering as many European countries are still facing higher debt issues and rising rates will also increase their cost of debt. Hence, ECB could stay behind Fed and BoE.
Below are key facts on all 3 countries that you must look upon.
Out of 3 central banks, Fed has higher chances of going hawkish once the job market meets the Fed’s expectation and inflation sustains well above the fed’s targeted levels for a reasonable time. Hence, we expect the US 10-year benchmark yield to resume its uptrend towards 1.80%-2.00% and the US dollar index to move towards 91.00-91.50 levels. After the Fed, BoE has a higher probability of odds to cut down their bond-buying program and turn hawkish but new variant fear looms over reopening, and hence we expect GBPUSD to retrace back below 1.40-1.3950 levels and find stiff resistance near 1.4250 levels. In Europe, ECB still has a long way to go hawkish, as debt-driven countries could not allow to lift-off support system. Hence, EURUSD has limited upside till 1.2250-1.2280 zone and could retrace back upto 1.2000-1.1950 levels over the short term.
(Amit Pabari is managing director at CR Forex Advisors. The views expressed are the author’s own.)