The European Central Bank’s full throttle easing program comes as the Fed backs away from its easy ways, and the distinction between the two could become even greater when the Fed meets later this month—meaning higher U.S. rates and a stronger dollar.
Some strategists expect the ECB’s surprisingly robust easing program, and improvements in the U.S. economy to combine to give the Fed leverage to extend more hawkish talons at its September meeting. They say it could strike the language about keeping rates low for a “considerable period” from its statement, more clearly signaling its move to normalcy, expected next year.
U.S. Treasury yields were higher after the ECB Thursday cut three key interest rates, including its refinancing rate to 0.05 percent. It also drove its deposit rate deeper into negative territory, now charging 0.20 percent to banks that park money overnight.
ECB President Mario Draghi added to the one-two punch with a commitment for a sizeable bond buying program for asset backed securities and covered bonds that would start in October.
The news stung the euro, which fell below 1.30 for the first time since July 2013. Thursday’s U.S. data was also dollar positive and weighed on Treasury prices, as stocks rallied. The ISM nonmanufacturing index rose to 59.6 in August from 58.7 in July, its best showing since 2005.
With the exception of German bunds, yields in Europe moved lower as the 10-year Treasury yield rose to 2.43 percent, following the German bund but breaking a trend of moving lower with the rest of Europe’s sovereigns.
“Finally the data is overwhelming the force of global bond markets. Today the data is starting to win,” said Jens Nordvig, global head of G-10 currency strategy at Nomura. “Certainly into this crucial FOMC meeting on the 17th, we’ll be going more and more in that direction.” Thursday’s ECB announcement was followed by U.S. data that showed services sector activity at its best pace since 2005.
ADP private payroll data also showed an increase of 204,000 private sector jobs in August. While less than expected, ADP reaffirmed market expectations that Friday’s government jobs report should show growth of more than 200,000 nonfarm payrolls for a seventh month. That jobs report is seen as a key element the Fed will consider when it meets starting Sept. 16.
“It really looks like U.S. data is finding a solid bottom, and the data is just literally on fire,” Nordvig said. “You have so many indicators that are at 10-year highs. ISM is the latest one. It’s a broad range of indicators that have totally broken out of the range of the last few years.”
Nordvig said the data is convincing him the Fed will be forced to acknowledge the positives in the U.S. economy by dropping the crucial language promising to keep interest rates low for a considerable period. But that does not mean it would move anytime sooner to raise rates, but it is acknowledging improvement by leaving the door open, he said.
The Fed has emphasized that its policy path is data dependent so any setback could slow its march toward normalization—and rate hikes. “We’re not going to to know until next year whether it’s March or June or September,” Nordvig said.
The Fed has been tapering back its “quantitative easing” bond buying program and is expected to end tapering in October. Many economists expect the Fed to make the first hike in short-term rates in the middle of next year.
David Ader, CRT Capital chief Treasury strategist, said the ECB’s move makes it more likely the Fed will change the language in its statement in September. He had expected the change in October.
“Now that they’ve done this, the Fed can do what it’s doing. It’s no longer inhibited by concerns of Europe not doing what it’s now doing,” Ader said. He added that Japan also reaffirmed its bond buying program. “Now, you have those central banks with their foot on the gas pedal. The Fed could ease off a little.”
Ward McCarthy, chief financial economist at Jefferies, however, said the Fed could be more leery of moving away from policy since the situation in Europe is forcing the ECB to carry out significant easing.
“Monetary policy is right now fixated on the labor market. Inflation is kind of an afterthought because it is still below target, and what that means is the Fed can continue to stimulate the economy to resuscitate the labor market at this point without worrying about inflation,” he said.
Draghi, in comments after the ECB meeting, said inflation expectations are anchored but downside risks are increasing. The European economy has been growing sluggishly and some countries saw negative GDP last quarter.
“I think the Fed starts raising rates later rather than sooner, and they want to be convinced they’ve exercised the deflation demons before they do so,” McCarthy said. “That means the Fed will probably be a little bit behind the curve.”
Peter Boockvar, chief market analyst at Lindsey Group, said while the stock market was rallying Thursday, investors could start to respond negatively if rates start rising.
“Outside of this initial cheer, I don’t see what the followup is on the upside,” Boockvar said. “In the stock market, if you’re a multinational corporation, you’re dealing with a stronger dollar against the euro and a weaker U.S. economy. I don’t know how this is good for corporate profits.”
Boockvar said the market may take note of the move toward higher rates. “They all love this kind of fix. But outside of today, we have to see what kind of follow through there is because there are implications of a strong dollar and weakness around the world and a Fed that’s reversing policy,” he said. “We’ve been rallying for three weeks going into today.”