Central banks are still too tight

Quick note: With the ECB’s policy statement today, it’s clear that a lot of major central banks are still running policy that is too tight given the emerging global growth slowdown. I mentioned the Bank of Canada yesterday. But I also wanted to highlight the Norwegian central bank in addition to the ECB and the Fed today.

The ECB manages expectations down but…

This comes via Reuters:

European Central Bank President Mario Draghi acknowledged on Thursday that economic growth in the euro zone was likely to be weaker than earlier expected due to the fall-out from factors ranging from China’s slowdown to Brexit

The region’s economy is already suffering its biggest slowdown in half a decade, raising questions over whether the ECB will be able to increase interest rates for the first time in a decade later this year as its current guidance indicates.

The ECB left that guidance and interest rates unchanged at its meeting on Thursday. But Draghi’s downbeat comments, including a reference to “downside” risks, will fuel market speculation that the bank will delay any rate hike, mirroring a more cautious approach by the U.S. Federal Reserve, and may offer new cheap loans to banks.

“The risks surrounding the euro area growth outlook have moved to the downside on account of the persistence of uncertainties,” Draghi told a news conference, citing trade and geopolitical threats and emerging market volatility.

And Draghi may allow Targeted Long-Term Refinancing Operations (TLTRO) operations to continue in order to keep the cheap money flowing to eurozone banks.

The ECB is fundamentally hawkish

Here’s the problem:

Despite citing the rising risks, Draghi nonetheless reeled off reasons for not changing policy now, notably the strength of the region’s labor market and rising wage growth, which he said would help push underlying inflation up over the medium term.

So, the policy bias in Europe is fundamentally hawkish, just as it is in the US. And that’s because both central banks see rising wages and low unemployment as an inflationary threat to be countered with rate hikes. So, at the first sign of clear skies, expect the ECB – and the Fed – to raise interest rates.

The Norwegians are positioned in the same way

The hawkish tilt is everywhere. And it’s at its most extreme in Norway. Here’s ING on Norges Bank’s policy statement:

As was widely expected, the Norwegian central bank kept rates on hold at today’s meeting. But the policy statement reiterated the crucial line that “the policy rate would most likely be raised in March 2019”.

This confirms our view that the NB is more likely to stick to its rate hiking plan than markets are currently pricing in, and more likely to retain a relatively hawkish policy stance compared to most other central banks over coming quarters.

Norway is not the only one raising rates. Remember, just yesterday Bank of Canada governor Stephen Poloz had to defend himself for having raised rates multiple times in the lead-up to the global growth slowdown.

Poloz fended off criticism that recent tightening by some central banks was ill conceived and said higher interest rates will eventually be warranted in Canada given the economy is already at near capacity with inflation at target.

“We are at a stage in the cycle where it always looks like monetary policy is doing the wrong thing,” Poloz said. Given the economy is “near its steady state, interest rates also should be near their steady state.”

Again, if the storm passes, the BoC will be raising rates again, just like Norway. The Fed and the ECB also want to raise rates, and are merely waiting for the global economy to recover in order to be able to do so.

My view

This is fundamentally bearish for risk assets. Although everyone is focused on the pullback in central bank tightening, the policy stance is still hawkish. And that impact will be felt greatest in the eurozone, where growth has slowed the most in advanced economies.

High-rated eurozone government bonds will continue to rally on this news. And while, Germany’s 10-year is trading below 20 basis points, it has been lower in the past. And Japan is trading just over 0%. This is where the 10-year Bund is headed over the long-term.

If you move out further on the risk spectrum to France, or even Ireland and Spain, you get more yield pickup with a deminimus increase in default risk. In my view, the growth problems for Europe will last for the longer term. This is not just a blip.