The European Central Bank keeps “steady hand” on policy stimulus, despite improving euro area growth and inflation prospects
US equity markets consolidated near all-time highs in the past week, with a dovish ECB and positive economic announcements, providing support. Investors appear to have relaxed their inflation concerns, as the S&P500 rose by 0.5% on Thursday 10th, despite CPI reaching its highest annual growth (5%) since 2008. Implied equity market volatility (VIX) declined to a 12-month low of 16%.
The Information Technology sector led the increase in the past week (+2%), with Banks underperforming. Lower long-term interest rates offer some potential explanation for the price action. The US Treasury yield declined by 10 basis points wow to 1.50%. Value tends to underperform Growth when interest rates fall. As the slope of the US Treasury yield curve flattens, the negative impact on Banks’ net interest margins and therefore, net interest income could be significant.
Looking forward, however, improving growth and core inflation, as well as the increasing likelihood that the Federal Reserve will take steps towards an eventual tapering of its large-scale asset purchases, suggest that nominal US Treasury yields could surpass their March peak (1.74%) in the coming months.
Attention now turns to the Fed meeting on June 16th and on how the “discussion about discussing” QE tapering (US Treasuries and agency MBSs), evolves.
Furthermore, the quarterly economic projections as well as the Federal Open Market Committee members’ assumptions regarding the appropriate path for the policy interest rate, will offer valuable insight into monetary policy prospects. Note that in March, the median of the 18 FOMC participants’ assessments pointed to near zero rates (0% - 0.25%) through 2023.
On the other side of the Atlantic, the ECB (June 10th) kept policy unchanged. As far as its pandemic emergency programme (PEPP) is concerned (total envelope: €1850 bn | holdings of €1126 bn as of June 11th), the ECB reiterated its expectation for maintaining a “significantly higher” pace of purchases over Q3:2021 (€20 bn per week) compared with the first months of 2021 (€14 bn per week) driving periphery government bond yields significantly lower.
The accompanying quarterly macro-economic projections revealed positive revisions regarding growth, with 2021 real GDP expected at +4.6% (from +4% in March) and 2022 real GDP expected at +4.7% (from +4.1% in March). The inflation outlook remains subdued, albeit with a modest upward drift through the forecasting horizon (HICP 2023: +1.4%).
The leaders of the Group of Seven (G7) agreed to launch a new global infrastructure plan “Build Back Better World (B3W)” for low- and middle-income countries, providing a western alternative to China’s “Belt and Road Initiative”, which has increased Beijing’s influence in the less developed countries.
Furthermore, the G7 will try to reach a global agreement on a minimum tax rate of 15% on a country-by-country basis at the July meeting of G20, to create a fairer tax system and reverse a 40-year race of declining tax rates to attract multinational companies.