On the eve of the Federal Reserve’s September meeting, Europe’s top central banker delivered a sharp reminder to markets that the world’s central banks are moving away from easy policies.
European Central Bank President Mario Draghi said in a speech Monday the “stable profile” of inflation “conceals a slowing contribution from the non-core components of the general index and a relatively vigorous pickup in underlying inflation.” Draghi’s inflation comment was viewed as hawkish, even though he repeated that the ECB does not intend to raise interest rates through next summer.
The euro rose, European stocks fell and European bond yields climbed, as traders took the comment to mean that inflation is stronger than expected, and that could mean rate hikes sooner. U.S. Treasury yields temporarily moved higher with European rates, as the German 10-year bund yield reached 0.50 percent.
“I think he’s referring to the forecast going forward, but I think this is part of a campaign,” said Marc Chandler, Bannockburn Global Forex’s chief market strategist. He noted that ECB policymaker Ewald Nowotny encouraged the ECB to speed up its exit from negative rate policies. “There seems to be a more hawkish slant on things.”
Two other ECB officials, Benoit Coeure and Peter Praet, said recently that the ECB will need to begin clarifying next year the likely path of interest rates, beyond the first hike.
Wednesday hike likely
The Fed is set to raise interest rates Wednesday by a quarter point and issue new forecasts for the economy, inflation and interest rates at the end of its two-day meeting. The Fed is well ahead of the ECB, which holds its deposit rate at negative 0.40 and will not end its quantitative easing program until the end of the year.
“Now we have central bankers that are getting more hawkish. It’s not just the Fed. It’s Draghi. To use the word ‘vigorous,’ he could have used a different word. That’s not a word to throw around lightly. We’re seeing a global change in monetary policy,” said Peter Boockvar, chief investment strategist at Bleakley Financial Group.
Boockvar said Japanese rates jumped last week, with the 40-year Japanese government bond yield rising to 1.05 percent after the Bank of Japan reduced the amount of long-term securities it was purchasing. “Norway raised rates, Canada is going to raise rates. This is all in the context of a very levered world. It’s something we have to pay attention to,” he said.
Draghi’s comments come as markets have begun to price in a more hawkish Fed. Expectations in the futures market have only just recently priced in the two rate hikes forecast by the Fed for this year. Nearly two are priced in for next year, while the Fed has forecast three.
The ECB has not expected to raise rates until the fourth quarter of 2019. “I’m not sure it materially changes the outlook in the medium term, in terms of ECB policy,” said Alan Ruskin, head of G-10 foreign exchange strategy at Deutsch Bank.
Ruskin said the market expectations for a European rate hike for next year moved slightly higher, and it’s possible it could come a little earlier. “One would argue that still probably the market is being more dovish. … He’s not signaling that he’s going to raise rates before 2019. … It does add up to the ECB being more hawkish than the market expects.”
The euro rose to as high as $1.1816 and was later at $1.1767.
“I think it’s more significant he’s saying this when the euro already appreciated from the $1.13 we saw in August. In six weeks the euro has gone up a nickel. If anything, inflation of the euro is going to dampen core prices. If we get much above $1.185, a lot of people become much more cautious.”
Chandler said the market will be watching European inflation data when it is released Friday.