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In markets tussle with central banks, neutral is the new hawkish
[ZURICH] Global investors are urging central bankers further and further down the monetary stimulus road, but they can't drag them all the way.
Easing by the Federal Reserve and the European Central Bank in the past week exposed divisions among policy makers, which may make further dovish action harder to push through. The market response on both sides of the Atlantic has been to drive yields higher in a sell-off that seemed to dismiss the fresh stimulus.
At the ECB, representatives from the euro area's two biggest economies were against some of the stimulus announced. Tension is building at the Fed, where a slim majority favors no further cuts. The balance of views is also in flux at the Bank of Japan, which on Thursday left the door open to easing at the next meeting.
"The market wants dovish central banks from the Fed to the ECB because it is in the business of running carry trades on a theme of Japanification - a mix of low growth and inflation," said Sebastien Galy at Nordea. "Yet at the same time, the market has run quite far ahead."
In the US, traders are leaning toward one more quarter-point cut this year, and adding to bets for two more next year. In Europe, money markets have pared positions, but see another ECB rate reduction by April.
Bond and currency markets have responded counter intuitively to the latest central bank actions. The US Treasury yield curve has flattened in a display of concern for the growth outlook and reduced confidence in the Fed's willingness to support it. Disappointment with the ECB's stimulus - which President Mario Draghi battled to deliver - sparked a selloff in government bonds that moved global rates higher, and the euro climbed.
While investors have a thirst for more easing, central banks seem inclined to take their time, assessing the impact of stimulus so far and incoming data - and, in the case of the ECB, the asset purchases to come.
That's creating a world where "neutral is the new hawkish." Citigroup analysts invoked this phrase last week as Canadian yields drifted higher on the central bank's unchanged stance.
BNP Paribas' Shahid Ladha said of the Fed's easing: "It's another case of a hawkish cut for me," adding that data will justify cuts in December, March and June next year.
The gloomy side of the global view was highlighted by the OECD on Thursday when it cut its forecast for world expansion to below 3 per cent and said trade tensions between China and the US are making the outlook "fragile and uncertain." But there are also those, including Blackstone Group co-founder Steve Schwarzman, who expect the conflict between the world's two biggest economies to ease.
With uncertainty so elevated, divisions among central bankers isn't perhaps so surprising.
At the Fed, the so-called "dot plot" showed seven officials projected one more cut this year, five believed rates should now stay where they are and five felt rates had already dropped too far.
While central banks may not be delivering the level of stimulus the market seems to want just yet, that doesn't mean they won't act if the situation worsens.
And in the meantime, some have increased the intensity of calls on governments to do more; the ECB's Draghi said last week that it's "high time" for such action. That's part of a growing recognition that central banks alone may not be able to bail the world economy out this time if growth continues to worsen.
"There are limits that we have to recognize," former ECB Vice President Vitor Constancio said this week. "Friedman instilled into economists' minds this idea that the central bank can put inflation in whatever level the central bank wants in a reasonable period of time. We are finding out it is not so simple."