The message conveyed was that the sell-off in the bond market has been a sign of a strengthening economy, not rising inflation concerns. The Fed duly raised its 2021 real GDP growth estimate at that meeting from 4.2% to 6.5% and the core PCE inflation forecast from 1.8% to 2.2%. In a speech in early March on the subject of monetary policy and the way out of the pandemic, Panetta stated that «by keeping nominal yields low for longer, we can provide a strong anchor to preserve accommodative financing conditions». This sounds to this writer like a policy of targeting nominal yields, which also implies potentially unlimited balance sheet expansion on the part of the ECB.
On this point, the ECB balance sheet is already much higher than the Federal Reserve’s as a percentage of GDP. Since the onset of the policy response to the pandemic, the ECB balance sheet has risen from €4.69tn or 39% of Eurozone annualised GDP at the end of February 2020 to €7.51tn or 66.5% of GDP. While the Fed balance sheet has risen from US$4.16tn or 19% of US annualised GDP to US$7.79tn or 37% of GDP over the same period. Indeed the ECB balance sheet has been rising at a more rapid rate than the Fed’s since mid-June 2020, rising by 41% in US dollar terms, compared with a 9% increase in the Fed’s balance sheet over the same period.
Meanwhile, as with the US, inflation expectations have been rising in the Eurozone as has broad money supply growth. Eurozone M3 growth was 12.5% YoY in January, the highest level since November 2007, and was 12.3% YoY in February. While the Eurozone 5-year 5-year forward inflation swap rate has risen from a low of 0.72% in March 2020 to 1.57% on 9 April 2021, the highest level since January 2019, and is now 1.52%. In this context, it is interesting to note that 16 German economists and businessmen filed a 140-page legal complaint accusing the ECB of «blatant monetary financing of states» in breach of Article 123 of the Lisbon Treaty last month .
Still the base case of this writer remains that legal challenges to the ECB through the German constitutional court will ultimately get nowhere unless they have the key political support. Indeed Panetta referred to this in his speech when he said that NGEU provides «an opportunity, for the first time ever, to achieve genuine European fiscal stabilisation backed by common debt issuance». That comment will not be music to the ears of hard-working German savers. Meanwhile, closet yield curve control in the Eurozone clearly has potentially bearish implications for the value of the euro since, as already noted, it implies unlimited balance sheet expansion.
Still, from another viewpoint, further moves towards fiscal union are euro bullish since they imply the German taxpayer underwriting the rest of the Eurozone which makes the fiscal situation sustainable for longer. German net government debt as a percentage of GDP was only an estimated 50% at the end of last year, according to the IMF, compared with 142% in Italy.
Source: Christopher Wood | Grizzle