Monetary normalization

Ten years after the last financial crisis, most of the big central banks still hold their ultra-loose monetary policies. Even though the ECB seemingly started to taper its QE programme, the money pumps will be on until the end of the year. However, due to base effects (and changing nominal pace of purchases), the ‘tapering’ started more than a year ago by now. The Bank of Japan kept his policy stance so far, although it is questionable how long can they buy assets without jeopardizing the smooth operation of private financial firms or their own solvency. The Fed also switched to a dovish tone lately. Correspondingly, the dollar index went through a mild correction following the Trump-rally in last year’s November and December. One of the reasons might be the fading of the expected policy rate difference between major central banks. Since commodity prices stabilized, inflation returned, and global trade was partly revived, expectations shifted to the upside. Europe might represent an exception, however the weighted 10-year-yield also took part in the global yield rise in the last half a year.

Nowadays the Eurozone still resembles to the international gold-standard system after WWI: fixed exchange rates with balance of payments imbalances. The main issue lies within the solution, governments have to rely solely on internal devaluation by following pro-cyclical policies. The problem with such measurement is its unpopularity, hence can not be held without political turbulences. Realizing the issue, the ECB is constantly trying to inflate the core-economies, while also trying to avoid a debt-deflation spiral in the periphery. Two birds with one stone, we could say. Lowering real debt burden, while they try to restore the balance between economies. Unfortunately, the households of the core do not cheer the measures as they feel the value of their savings eroding.

The strength in the euro and raising core government bond yields are more likely to be due to the favourable result of the French election regarding the unity of the monetary bloc. The insurance premiums (= chance of the Eurozone falling apart * appreciation in national currency) faded, however, the internal imbalances are still present in the system. Given the latter condition, I would be surprised if the ECB would rush with its policy normalization, inflation tolerance will be higher. Negative real rates are still needed and it seems they are here to stay with us.

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