Global CIO Commentary by Scott Minerd
Now is the time for strong action from the European Central Bank, as policymakers meet on Thursday to decide how to combat low inflation and muted credit growth. With euro zone inflation at just over one quarter of its target, the ECB is under pressure to act. My advice for Dr. Mario Draghi and his fellow policymakers is to use the big bazooka, to take a shock-and-awe approach, and promise more action if needed. Whether the ECB proposes negative deposit rates, a new Long Term Refinancing Operation (LTRO) or another option; over the coming months, European monetary policy will likely help drive interest rates lower and the U.S. dollar higher.
European quantitative easing, whatever its form, will likely drive yields down, sending money elsewhere in search of yield and forcing the euro currency below its current level of 1.36 U.S. dollars. Of course, this will likely drive even more capital toward the United States. That could prompt a decline in U.S. Treasury yields over the summer, at a time when investors would otherwise expect interest rates to be rising because of an improving American economy and tentative signs of an uptick in U.S. inflation.
On balance, the U.S. economy continues to do well; with central bank liquidity flowing into global markets, the investment environment remains positive for bonds, equities, and credit. Last week, first-quarter U.S. GDP was revised lower to -1 percent, the first negative reading after three uninterrupted years of economic expansion. However, investors need not be alarmed. The GDP revision reflected the effect of the severe winter soft patch, which hit fixed investment and inventories particularly hard. Importantly, consumer spending, which accounts for 70 percent of U.S. economic activity, grew at 3.1 percent and is a better reflection of the underlying strength of the American economy. Of course, we must be conscious that we may well be moving into the realm of markets overheating. It is important to remember that with careful market analysis, speculative markets are often the most rewarding.
Taylor Rule Suggests Further Euro Zone Monetary Accommodation
Most central banks in major advanced economies are running ultra-loose monetary policies, with the exception of the European Central Bank in the euro zone. According to the Taylor Rule, which measures optimal interest rates based on inflation and labor market conditions, the euro zone is the only advanced economy running at a higher policy rate than the rule suggests. To date, the huge divergence in economic fundamentals between core and periphery nations has prevented the ECB from conducting more monetary accommodation. With elevated unemployment and a rising risk of deflation however, ECB policymakers have gradually shifted toward an easing bias, which should be apparent at Thursday’s meeting.
CENTRAL BANK RATES IN MAJOR ADVANCED ECONOMIES VS. TAYLOR RULE SUGGESTED RATES*
Source: Bloomberg, Guggenheim Investments. Data as of 6/4/2014. *Note: We use the same coefficients in the baseline Taylor Rule model for all countries to make the comparison more useful.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
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*Assets under management is as of 09.30.2018 and includes leverage of $11.8bn. Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"), which includes Security Investors, LLC ("SI"), Guggenheim Funds Investment Advisors, LLC, ("GFIA") and Guggenheim Partners Investment Management ("GPIM") the investment advisers to the referenced funds. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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