To the markets it seems as if the most important part of the much awaited speeches by the US Fed Reserve chairman Janet Yellen and the European Central Bank president Mario Draghi at the annual Jackson Hole symposium last week were the bits they left out.
At an event entitled "Fostering a Dynamic Global Economy" markets had wanted to hear something about balance sheet normalisation from Ms Yellen, and about QE (quantitative easing) tapering from Mr Draghi. In the event they got neither. Not only this, but Mr Draghi also failed to make any comments about the strength of the euro, which was taken as a green light to push it higher, reaching its highest levels since January 2015 and just below 1.20 by Friday’s close.
Instead of discussing the condition of the US economy and on the implication for interest rates or the Fed’s US$4.5 trillion balance sheet, Ms Yellen’s speech focused on the post-crisis tightening of financial regulation and the need for it to be kept largely in place. She argued that such tightening of regulation had no "readily apparent" adverse effects on credit availability, market liquidity or economic growth, and concluded that "any adjustments to the regulatory framework should be modest". As such the main target of her speech was not so much the financial markets but rather the White House, putting her potentially on a collision course with the US president Donald Trump who has pledged to slash financial regulation and in particular the Dodd Frank banking law.
Mr Draghi’s speech also took aim at global leaders rather than addressing the concerns of the financial markets. He hit out against protectionism and he argued for the need to raise potential output growth by doing more to increase productivity. In claiming that "openness to trade is under threat" he called for a multilateral response. Dovetailing his comments with Ms Yellen’s, Mr Draghi also addressed the issue of regulation saying that any reversal of the regulatory response to the financial crisis "would call into question whether the lessons of the crisis have indeed been learnt".
The absence of any meaningful discussion of monetary policy by either central bank leader was taken by markets as a signal that the Fed is in no hurry to raise interest rates, and that the ECB is little concerned by the strength of the euro’s exchange rate. However, the more subliminal message was perhaps less clear cut.
Mr Draghi’s remarks about regulation appeared premised on the assumption that global monetary policy, and most probably ECB monetary policy, would remain accommodative. Mr Draghi observed that "with monetary policy globally very expansionary, regulators should be wary of rekindling the incentives that led to the crisis". No indication then that ECB monetary policy was about to become materially less expansionary, but rather that the onus was on regulators to hold the line. In the subsequent discussion he appeared to go further by indicating that a self-sustained convergence of inflation toward the ECB’s goal is still nowhere in sight. Markets will now have to wait a fortnight to the next ECB meeting to see if the case for tapering has advanced at all, but in the light of the latest euro-zone inflation data that showed price gains steady at 1.3 per cent in July, it seems unlikely that it will have. Furthermore, another fortnight of euro gains is only likely to tilt the balance against making a pre-emptive move towards winding down the pace of ECB debt purchases.
As far as Ms Yellen’s Fed is concerned, the absence of any overt message about balance sheet normalisation and interest rates hikes in last week’s speech was to be expected and has little to no implications for either of these policy tools over the rest of the year. Admittedly the Fed is unlikely to raise interest rates at the upcoming meeting in September but for the markets to have priced them out completely over the rest of the year is something that with four months to go seems highly premature. Indeed going forward the reverse of the ECB’s concerns about the euro’s strength seem likely to apply, as continued dollar depreciation is only going to make financial conditions looser in the United States, tipping the balance in favour of a Fed rate hike by December, not against.
Tim Fox is Head of Research & Chief Economist at Emirates NBD