Surveillance: ECB Surprise (Podcast)

market reaction makes sense. Um, we got fifty basis points, which is kind of in line with you know, the Bloomberg story that came out a few a few days ago. Clearly, the points that you've been making about forward guidance apply not just to you, not just to ECB, but to other central banks as well. We've seen those quick turnarounds and changes of mind. And and look, I mean that's that's the inflation picture in Europe and globally. It just

forces central banks to front load. It really made no sense to end up with negative rates at the end of this meeting. And and and that's what that's what the CB decided. To Tom's point, I think the fragmentation tool is probably longer turn the more important, the more important variable for the Euros. So we're gonna see, we're gonna be anxious to see, um all the details from vastly to me, what's so important here is nonlinearity. We're getting to a restrictive state within the Central Bank of

the United States. We're nowhere near that with the e c B. How nonlinears Leaguard's trip to the end of two thousand twenty two, and in the next year, this gets ever more difficult, doesn't it. It doesn't, It doesn't get easy. I think the problem for the some of the central banks that are front loading right now if you get a front load and then get to neutral and then stop, but inflation is not slowing than than

what do you do right? Uh? The CB is going a little bit slower as you point as you're pointing out, at least they're starting later. What we do think they probably get to you know, at least one and a half percent by by next year, which which is starting to push them into into a neutral or restrictive as well. But again, the key variable here's this, quite how quickly can inflation start coming down? Uh? In order for those central banks are actually to actually stop where they think

they're gonna stop. And that's uh, that's probably you know, that's probably the key question for the markets. And then of course, I think increasingly from here it's it's you're going to be the growth inflation mix, right, the growth inflation mix has been very, very bad. Um, they're hoping it's it's you know, they can hike without triggering and even deep a downturn. But that's that's very mution open questions.

Well to that point, for silly, can this bounce we're seeing in the euro stick Yeah, it's very hard to see that stick for a very long time. And I think the problem is it's not just about the fragmentation, right, So what we'll see about the details of this instrument, um. I with Tom's point in the sense that you know, if it's open ended, that's a that's a very good signal, um Right, if it's not, if it's not limited, um, that might get us to let's say one or three,

one or three and a half. As far as the you're a dollar. The problem is that some of the bigger, bigger issues related to European growth are still there, right, and this is gas supplies, um, and how what are we going to do this winter? So in that sense, I think investors, most investors do it. We talked to are still um, quite negative on the euro and and and probably you know, getting ready to sell to sell

the rallies. Um. The whatever the e CP does today unfortunately doesn't really change the threat of a deeper downturn um, you know, in the next six months if indeed we moved to things like um, you know, energy supply rationing in Europe. I have a silly, truly historic I'm been able to say these words for a long time. Have we cilly cetub break off? There have ups the first interest right high from the e CP since twenty eleven,

giom Wack. We are honored that he is with us today, is the chief economistic acts investment management and is arguably the most read acts in market economics in Europe. So let me ask you an open question right now, what will you listen for X and or ex post from Christine Lagarde. Um, it's going to be an interesting sell for a cassing again because um, what they've actually done today is by going to fifty, whereas they add actually telegraphed twenty five. They've basically get rid got rid of

forward guidance. We used to have a pretty precise followard guidance from from the CD and since they've done something which is quite different from what they had announced last time. Accordingly, uh they have just said that for the next moves, for the next decisions, it will be a meeting by

meeting process. It would be completely data dependent. So I guess journalists are going to try to extract as much information from Casina gald as to what the next moves are going to be, and I would expect her to be extremely guarded because that's a new regime. Basically, we have a central bank today which is saying us, okay, I read the band aid, I got fifty and sorry, I told you something different in June, and for one's going to come up next well, we'll see. So it's

going to be I think an interesting debate. The other issue, obviously is on the rules of engagement of of TPI S. It's you know, that is the name of the anti fragmentation weapon. It's likely to be quite a big instrument and possibly a convincing instrument on paper. We'll have the details a bit later. But the question everyone has is what are the conditions, what are the circumstances under which

you would actually activate it? And um consensus right now and I agree with that is that given the nature of the crisis currently in Italy, which is a home ground political crisis, it's unlike clear that you could use an antifragmentation instrument to deal with this. So I guess Christinagan is going to have a lot of questions on you know, what are exactly does engage controls? So you know there's two points there. There's one on interest rates and the other is on t P. I let's just

start with rates and finish up there. They're not going to give us a guide towards what they're going to do in September. I get all of that. Which she needs to establish in this news conference is the reaction function of the ECB. What they have led us to believe is that the next move is a hike. They're basically saying that further normalization of interest rates will be appropriate. What they're not telling us is the size of that hike.

Do you have a decent understanding of what the economic data points will be the influence the decision between twenty five and fifty, and how we're meant to understand the incoming data, internalize that and come up with a view

about what this means for ECB rate hikes. Well, clearly, you know CPO prints that will be important even if by September, honestly there's you know, we are unlikely to have a big change actually into kind of information will get from from CPO prints, So you probably probably want to go up the pipeline basically of of inflationary pressure.

I think a key issue is what's going to happen with with wage growth, and that's a problem we have specifically in Europe because data reliable data on wage growth come very very late and much later than they do in the US. So when you have a central bankmaking decisions basically on the risks of second round effects from from inflation, you need to know exactly where the labor market is going and whether or not we are seeing

some proper in a wage acceleration. So that is going to be to be to be key and probably also a side issue which is unfortunately very binary and which actually probably explains why these doesn't want to give us any kind of forward guidance is what the Russian is going to do with gas, because news today is that apparently there's at least a trickle of gas supply going

through north Stream one. But we never know whether or not this is going to be uh, this to continue for several month, whether or not will have another maintenance period in which the Russians cuts access to gas, and that is superbinary. In Europe. Basically the border between stagnation and the proper significant recession is whether or not we still have access to Russian gas by by the winter. So that might actually be quite an important input in

their in their reaction function. You're just briefly then on t P I. The conditionality around this hard to make it cool at the moment, but best guess what do you think it will be. I don't think it's going to be big. I think it's going to be about, you know, the next generation YOU program is going to be about you know, complying with the European surveillance physical surveillance rules which actually at the moment have been have been suspended. I don't think is going to be heavy.

The problem is that for those milestones to be ticked for this to be for this even like contionality to be complied with. You need a government. You need a government in Italy that actually plays place according to the rules,

and that's a big Christian market the moment. Well, and there's a conversation happening on our type top live blog on the Bloomberg terminal right now about the fact that you've got the fifty basis points, which appeases the hawks, but you also got at the same time this tp I, which appeases the doves, because then you have a crisis management tool to ensure that the transmission is smooth. If it doesn't work as intended, does the ECP get stuck

here at zero? It's it's it's it's a possibility, I would I would doubt it, because my impression is that you know, they've raised the bar quite high. They really really want to normalize. Now. It's true that once you've hit zero, possibly the debate changes a little bit because at the Goblin Council get a number of people, including among the dogs, who never actually liked negative interest rate in the first place. We've always thought they was controversial,

possibly counterproductive. Once you've brought post rates to zero, it's a slightly different conversation. However, given the kind of inflation we have the pipeline, it would take a lot, I think for the CD two to stop normalizing from from where we are right now. Okay, so maybe they won't stop normalizing entirely, but how much do you think they'll actually be able to normalize? What rate do you think they will get to before the economy forces them to stop.

My forecast is that at the end of year there at one percent, which is the lower end of the range that they gave us for what they consider to be um neutral rates. Uh So, end of twenty three, if we avoid a catastrophe a link to to to the gas situation, they might go to the middle of that neutral range, around one fifty. But that would probably the maximum of what I could expect. Then there is a significant risk that they get stuck at one percent if we we end up with a very significant slowdown

and if you wage growth desiderates instead of externating. But the natural slope I think for the CP is to really get at least into this neutral range, which is at least I think I've been taking to you on of for about ten years, and this is the first time we've got to talk about right hike from the e c BO. Thank you, Mark of Extra Investment Management.

We've got Mark Chandler Bonnockburn Chief Market Strategies here. Mark, Tom and I were just talking about kind of what we've seen from the e c B this morning, the surprise fifty basis point rate hike. We saw strength initially in the euro, but it seemed to be giving that up. What are your takeaways? Yes, so I think you're right. I think that the ECB surprised many people by hiking

fifty basis points. To Bloomberg had the leak earlier this weekend, when the leak first came out and unsourced reports saying that you know, officials close to the ECB are talking about a fifty basis point hike, I recognize that as a likely quid pro quote for the for what now the Guard calls a TPI, the transmission protection instrument. I think that the market had been set up for a by the rumor sell the fact. In any event, you

think about what's happened. The euro rallied about ninety nine and a half cents to about one oh two and a half cent in the first three or four days of this week, and so I thought this was a short covering move. And I think now the focus shifts to the stud of reserve, which is going to high grates, most likely by seventy five basis points next week. That means that the rate differential, the policy rate differential is moving in the US is favored by twenty five basis

points this month. Okay, the rate differentials there, but also it's about confidence in the economy and Mark Chandler, and you've been so good about folding in foreign exchange dynamics over to what g d P actually does. There's a headline in the blur here where she says their run rate is there's no recession in Europe. Do you buy that? Yeah? I think you know that. I think is just the typical kind of central bank talk. I mean, what's Cyple

Bank really forecast of recession like the FED doesn't. I think that the odds of a European recession are in preasing, but I think the odds of the U S re session are increasing too. In Powell is not going to say that next week. Do you have a call in euro at Bannockburndeed, you you know, do you have it? Can you give us a single point call five days out in Euro five days out, I think we're gonna be lower. I think that we're gonna be having to go back and test at nine and nine and a

half cent area that we saw last week. And I think I would expect that before the f O m C meets and you know when they before they make the decision at seventy five basis points a dollar goes better bid. You know, besides the ECB, the other big the other big thing today, of course, is that Italy political crisis and those spreads are widening, and typically those widening spreads works against the Europe. They a candidate for

the t P I a crisis tool. Well, you know, I think that Leguard try to put the best face on it, but first she told us it's a secondary tool. The first tool is gonna be the flexibility with the recycling or reinvesting of the emergency purchases they already made. I think the euro going through yesterday's low, this is really setting up a very poor technical condition for the next few days. I mean, Paul I make jokes about it, but I adore Clause Reggling, who I've seen twice in

the last six months. Who's at the absolute pivot point of these discussions. He is an esteemed diplomat and economist from Germany. And I can't fathom le Guard and Reggling talking about the future of Italy. I can't imagine it's it's always it seems like it's always a front and center mark. So as we think about the US Federal Reserve, we think about July, we train our attention on that. In your mind, is a hunter basis points off the

table completely? Well, I think the market is pricing in about a one in five chance it had taken place. I think that the odds of it are really you know, look at what happened today with the Philly Fed survey. What a big myth, and so I don't think that. I don't think this is going to stay of sedand I think they just want to do a measured pace seven fight. The market is giving them seventy five dabs points. I think they want to take that. So what are

the key issues here? Uh? From your perspective, as you think about kind of where this economy is going, you know, how much credit do you give the Fed here? I guess for trying to find that balance between fighting inflation and preventing recession. I don't really see the FED pretty much emphasis in the resistant recession. I mean they I mean, I think Powells really says it right. I mean, I think he says, we're really determined to curb inflation. We hope we can, we can avoid a recession. To me,

that's like asymmetrical, like surrect perception. So I don't see I don't see the FED really trying hard to avoid a recession. I think they're more much more focused on inflation. And I think, you know, because so long these people cried for a Voker moment, and now they've got a Vocer moment and to get afraid of it. Mark Chan, thank you so much. Too. Short of visit with Bannock Burden this morning. This is the Bloomberg Surveillance Podcast. Thanks

for listening. Join us live weekdays from seven ten a m. Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple, podcast, SoundCloud, Bloomberg dot com, and of course, on the terminal I'm Tom Keene, and this is Bloomberg.