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Draghi-Yellen split to revive markets

LiveMint logoLiveMint 05-06-2014 Simon Kennedy

London: Central banks are poised to reawaken the financial markets they had hypnotized into a slumber.

The source of the stirring lies in signs policy makers are set to diverge from the united front they adopted following the financial crisis. The result will leave investors with more money-making opportunities after the ongoing easy-money era becalmed trading in everything from bonds to currencies.

European Central Bank (ECB) president Mario Draghi is poised to add to global liquidity as soon as Thursday, amid expectations he will cut interest rates and leave the door open to quantitative easing.

That will be at mounting odds with the trend elsewhere. Federal Reserve chair Janet Yellen is winding down the bank’s monthly asset purchases and economists are pulling forward their forecasts for a rate hike from the Bank of England. Splitting the difference is the Bank of Japan as it continues with its asset purchase programme unleashed in April 2013 while pushing against speculation it will expand it.

In a taste of things to come, the scheduled ECB meeting alone led dollar volatility to surge to the highest in a year versus the euro. Price swings in Treasuries rose to a two-month high.

The growing diversity is even more evident in Morgan Stanley’s outlook for the 16 central banks it follows closely. Seven monetary authorities, mainly in emerging markets, have a bias to tighten monetary policy, while nine lean toward easing.

The policy divergences will widen even further over the next three years as the Fed and then the BOE raise rates, putting them on a course counter to the ECB and the BOJ, according to Andrew Kenningham, an economist at Capital Economics Ltd. in London. By 2017, he estimates, the gap between the US benchmark and those of the euro area and Japan could be nearing four percentage points.

Such divides, he says, are unusual although not unprecedented. The split between US and Japanese rates has often exceeded four percentage points in recent decades and between the US and Germany it topped three percentage points for much of the 1980s.

The end of unanimity would nevertheless have a substantial influence on financial markets, with the gap in bond yields between the US and elsewhere widening and the dollar probably rising, said Kenningham.

More market volatility may be something central bankers welcome after several turned vocal in recent weeks about the calm. The concern was it could provoke excessive risk-taking.

If policy makers can active the markets they can perhaps quell the threat of asset bubbles and also keep interest rates low enough to boost economic growth, said Steven Englander, the New York-based global head of Group of 10 foreign-exchange strategy at Citigroup Inc.

We are assuming that higher volatility will discourage yield grabs in asset markets more than it discourages activity, said Englander in a 30 May report. BLOOMBERG

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