Large uncertainty about Scottish referendum outcome (NIBC)

The Chart of the Week shows government bond yields of Germany, the Netherlands, Belgium and Spain. The ECB announced its first official QE programme early this month. The chart shows that rather than falling, interest rates actually rose since then. This contradicts with the popular view that more liquidity will result in higher bond prices (i.e. lower yields), but we regularly discussed that this is not an illogical development.

After all, the shorter-part of the yield curve could still benefit from central bank support, but if monetary easing programmes work as they are intended to do (i.e. increase economic growth and inflation prospects) - or at least as long as people believe they do - this should be reflected in higher longer-term bond yields.

United States

  • This Wednesday, the central bank of the US will attract all attention as its policymakers will release their latest economic projections and the FOMC statement that day. We expect the Fed’s median projections for 2017 to show that the fed funds rate will be close to 3.5%. Bond markets seem to strongly disagree with the Fed’s FOMC members given that US Treasury yields are far lower than where the Fed expects its overnight main policy rate (the fed funds rate) to go in the coming years.

  • We remember many people saying ‘don’t fight the Fed’ when the central bank was in an easing mode. So, has that phrase become obsolete now the easing cycle has ended: is this time different?

  • Financial markets continue to deny the Fed’s message, whatever the central bank’s policymakers say. This may be an inheritance of the past years when central bankers promised to keep rates lower for long. Therefore, as time passes by, central bankers will increase their efforts to convince that it will raise rates.

  • There was no single reason from last week’s data why the Fed should wait with hiking rates, in our view. The consumer credit report showed that consumer borrowing increased by USD 26.0bn in July after USD 18.8bn in June, while the NFIB small business index rose 0.4 points to 96.1 in August, just 1.7 points below its long-run average level.

    Eurozone

  • Prospects for a boost to the ECB’s balance sheet by the liquidity injections and QE have resulted in downward pressures on the euro. No magic there. What was a less welcome development for ECB members is that the ECB’s preferred measure for medium-inflation expectations dropped again below 2%. The ECB therefore remains under significant pressures from the markets.

  • Talking about inflation, or actually the fear for deflation, last week’s data showed that German labour costs rose to 1.7% in the second quarter and a further pick-up in wage growth should certainly not be ruled out. What was also quite positive was that German exports rose 4.7% (mom) in July to a record high. Together with strong industrial production and factory order data, the German economy has started the third quarter on a strong footing.

  • Data from the other expected outperformer within the eurozone for this year from an economic perspective, Spain, was also fairly encouraging the past weeks. We would like to underline that the country’s annual CPI inflation rate has been hovering around 0% since late-2013 and is even negative the past two months. The negative inflation rates are a consequence of the build-up of excess capacity especially before the crisis.

  • Uncompetitive economies where domestic demand is hurt by stockpiles of debt will probably not even grow strongly when interest rates are 0%. Italy and France remain the weakest performers in the eurozone and as a consequence they constantly miss debt and deficit targets.

  • That said, politics will continue to play an important role for financial markets. In France, for example, a poll indicate that a majority of French people want Hollande (with an approval rate of 13%) to step down, while National Front under leader Le Pen has steadily gained popularity. Even if we had thought that the crisis was over, the ECB’s actions and these kinds of developments would have brought our feet back on the ground.

  • This week, the (first) TLTRO allotment will be announced on Thursday.

    United Kingdom

  • Last week’s data have been overshadowed by the last Scotland independence vote polls. We don’t think a Yes outcome will be as disastrous for Scotland as the No camp would like us to believe. Yet, a vote for independence would have a negative effect on both the UK and Scottish economy and introduce a huge amount of uncertainty as a Scottish separation from the rest of the UK would require long and complex negotiations.

  • One of the key economic uncertainties for Scotland is what currency it will use after voting for independence. We think that Scotland keeping (officially or unofficially) the pound is the most likely option in case of an independent Scotland.

  • A big negative for Scotland could be capital flights. Some investors already ventilated that they are reducing their GBP bond portfolio holdings due to currency risk, while several companies said that they had contingency plans to move headquarters out of Scotland. This will probably have increased international investors’ concerns about the risks of their investments in Scotland.