At last Thursday’s European Central Bank (ECB) meeting in Latvia, president Mario Draghi said, "we anticipate that, after September 2018, subject to incoming data confirming our medium-term inflation outlook, we will reduce the monthly pace of the net asset purchases to €15bn (£13.18bn) until the end of December 2018 and then end net purchases". In other words, they would at last end quantitive easing, having ratcheted up €2.4 trillion-worth of assets since it was launched early in 2015. He added that there was no chance of a rate rise until next summer – at the earliest – on which the value of a Bund future rallied smartly (10-year yields down to 0.333 per cent and just 50 basis points above 2016’s record low); Spanish 10-year Bonos just 40 basis points above their all-time low. A spectacular, counter-intuitive result.
This Tuesday in Portugal he added "we will remain patient in determining the timing of the first rate rise and will take a gradual approach to adjusting policy thereafter. The path of very short-term interest rates that is implicit in the term structure of today’s money market interest rates broadly reflects these principles." He’s talking about the infamous Euribor futures contracts where this July’s one estimates three-month money to cost 32 basis points while the September 2019 delivery discounts just 20 basis points. In fact, contracts are currently pricing in negative rates until March 2020. Slow, or snail-paced? Before his comments the curve was priced for 10 basis points’ worth of higher interest rates in all contract months.
The US Federal Reserve has been a bit more successful with rate rises, inching up 25 basis points in 2016 from a record low 25 basis points, managing another two 25 basis point increases in 2017, 2018 and, so far, this year; the upper end of its target rate now lies at 2 per cent – way below what many would consider ‘normal’. The real problem is that market-set rates in the US Treasury yield curve have not moved in tandem – two-year Notes currently yielding 2.50 per cent, 10-year 2.86 and 30-year 3.00 per cent. That’s just 100 basis points over Fed Funds and the yield curve is at its flattest since August 2007, down from 400 basis point yield 'pick up' between two- and 30-year paper early in 2011. Not a good omen for the economy. Also problematic is that the yield on 10-year Notes at 260 basis points over Bund is at its widest since the introduction of the euro. Unhelpful in a trade war.
The Bank of England, all too eager to shift the rate-setting lever or threatening to do so, slashed Bank Rate to a record low 50 basis points early in 2009 (in line with the US), then felt the need to tinker post-Brexit referendum to another record low 25 basis points, back up again to 50 late last year. Tiny moves like these are irrelevant to the UK yield curve where two-year gilts have held between a record low 5 basis points and 1 per cent since 2011. Ten-year paper, currently yielding 1.27 per cent, remains below what had been a record during the eurozone crisis in 2012. Thirty-year paper at 1.75 per cent is just 50 basis points over its 2016 record low yield. Probably best if the Bank of England does nothing and lets gilt yields drift lower until we exit the European Union.
