recent market developments by jorge sicilia, chief economist bbva group (may 2014)
DESCRIPTION
Financial markets Macroeconomic outlook Inflation expectations Fragmentation and its impact on monetary policy: a comment on forward guidance Some preliminary remarks on QE Issues for discussion: challengesTRANSCRIPT
Recent market developments.
Jorge Sicilia, Chief Economist BBVA
Foreign Exchange Contact Group
Frankfurt, 6 May 2014
Foreign Exchange Contact Group
6 May 2014
Page 2
Financial markets
Macroeconomic outlook
Inflation expectations
Fragmentation and its impact on monetary policy: a comment on forward guidance
Some preliminary remarks on QE
Issues for discussion: challenges
Contents
Foreign Exchange Contact Group
6 May 2014
Page 3
Renewed tensions in EMEA have not spread, but still a source of concern for the global and European outlook
Financial tensions Index, Developed vs Emerging marketsSource: BBVA Research
-1,00
-0,50
0,00
0,50
1,00
1,50
2,00
-0,2
-0,1
0,1
0,2
0,3
2011 2012 2013 2014
Latam Emea Emerging Asia Developed (rhs)
Foreign Exchange Contact Group
6 May 2014
Page 4
-110
-90
-70
-50
-30
-10
10
30
0,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
4,5
5,0
1Y 2Y 3Y 4Y 5Y 6Y 7Y 10Y
bps change(rhs) 6-Apr 4-May
-110
-90
-70
-50
-30
-10
10
30
0,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
4,5
1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 15Y 20Y 25Y 30Y
bps change(rhs) 6-Apr 4-May
-110
-90
-70
-50
-30
-10
10
30
0,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
4,5
5,0
1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 15Y 20Y 25Y 30Y
bps change(rhs) 6-Apr 4-May
European periphery bond yieldsmonthly and YTD change, bpsSource: Bloomberg and BBVA Research
QE talks lend support to periphery bonds, mostly in the mid and long-end of the curves.
SPAIN ITALY PORTUGAL
Foreign Exchange Contact Group
6 May 2014
Page 5
FX: EM´s recent appreciation is fading, while the EUR has yet to price-in “QE talks”.
DXY dollar Index against major peersSource: Bloomberg and BBVA Research
FX vs USD, monthly change, %Source: Bloomberg and BBVA Research
-5 -3 -1 1 3 5
Indonesia
China
India
Hong Kong
Malaysia
Thailand
Taiwan
Philippines
Korea
Chile
Mexico
Argentina
Peru
Brazil
Colombia
Turkey
Russia
Ukraine
Poland
Hungary
Bulgaria
Czech Republic
Romania
ADXY - Asia
LACI - Latam
Japan
Euro
GBP
Dollar (DXY)
Appreciation against the
USD
60
65
70
75
80
85
90
95
100
105
110
Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14
BRL Turkey MXN PEN CLP COP ARS EUR
depreciation vs USD
Foreign Exchange Contact Group
6 May 2014
Page 6
Capital has been entering into both EM and periphery economies, but inflows are slowing down.
*Grey areas represent last month portfolio flows
Portfolio Flows: current and previous month(Country Flows over total Assets, % )Source: BBVA Research through EPFR data
Led by institutional investors, EM inflows have been positive in April. Yet they have been slowing down in the last three weeks
(mainly those to EMEA).
Led by institutional investors, EM inflows have been positive in April. Yet they have been slowing down in the last three weeks
(mainly those to EMEA).
Very positive inflows into peripheral bonds are also weakening, and turned into
outflows on the week ended on 30 April.
Very positive inflows into peripheral bonds are also weakening, and turned into
outflows on the week ended on 30 April.
-4,0 -3,0 -2,0 -1,0 0,0 1,0 2,0 3,0 4,0
USA
Japan
Canada
UK
Sweeden
Norway
Denmark
Finland
Germany
Austria
Netherlands
France
Belgium
Italy
Spain
Ireland
Portugal
Greece
Poland
Czech Rep
Hungary
Turkey
Russia
Mexico
Brazil
Chile
Colombia
Peru
Argentina
China
India
Korea
Thailand
Indonesia
Philippines
Hong Kong
Singapore
Foreign Exchange Contact Group
6 May 2014
Page 7
Financial markets
Macroeconomic outlook
Inflation expectations
Fragmentation and its impact on monetary policy: a comment on forward guidance
Some preliminary remarks on QE
Issues for discussion: challenges
Contents
Foreign Exchange Contact Group
6 May 2014
Page 8
World GDP Growth (% QoQ)based on BBVA-GAINSource: BBVA Research
Global Cycle: growth is still robust but around 0.8%
Overall, higher growth in developed economies partly offsets lower growth in emerging economies
0,0
0,2
0,4
0,6
0,8
1,0
1,2
3Monthsago
Current 3Monthsago
Current
Q2-13 Q3-13 Q4-13 Q1-14 Q2-14
Actual Estimates
Foreign Exchange Contact Group
6 May 2014
Page 9
The eurozone: the economic growth gains momentum, as expected
Domestic demand will contribute to the recovery in 2014, especially investment, with resilient private consumption
External support could lessen in the forecast horizon, due to the strength of the euro
Ongoing banking union and subdued financial stress should support the credit recovery in 2015
Eurozone: GDP growth (YoY)Source: BBVA Research
-0,6-0,4
1,1
1,9
-1,0
-0,5
0,0
0,5
1,0
1,5
2,0
2012 2013 2014 2015
Foreign Exchange Contact Group
6 May 2014
Page 10
Across the eurozone countries: a widespread mild recovery
Germany continues to lead the eurozone. Unchanged outlook, though some measures agreed by the new government depart from recent stance.
Germany continues to lead the eurozone. Unchanged outlook, though some measures agreed by the new government depart from recent stance.
France: Still lacking a firm recovery. France: Still lacking a firm recovery.
Italy: The economy is recovering, with more political stability and some promising reform initiatives that need to be implemented
-2,5
-2,0
-1,5
-1,0
-0,5
0,0
0,5
1,0
1,5
2,0
2,5
2013 2014 2015 2013 2014 2015 2013 2014 2015 2013 2014 2015
EMU Germany France Italy
Eurozone countries: GDP growth (YoY)Source: BBVA Research
Foreign Exchange Contact Group
6 May 2014
Page 11
Spain: GDP growth (YoY)Source: BBVA Research
Strong export growth as export prices offsets euro appreciation while domestic demand picks up in a context of fiscal adjustment
Spain: gradual recovery after a long recession
Investment in M&E grows faster than average EMU and improves medium-term GDP growth outlook
Risks ahead: both external (Euro appreciation, deflation) and domestic (Reform fatigue, the Catalonia issue)
-1,6-1,2
1,1
1,9
-2,0
-1,5
-1,0
-0,5
0,0
0,5
1,0
1,5
2,0
2,5
2012 2013 2014 2015
Foreign Exchange Contact Group
6 May 2014
Page 12
Eurozone: stronger domestic demand for 1Q14
Confidence indicators were consistent with economic activity in the eurozone gaining traction,
still led by Germany but also with a better outlook in the periphery
Confidence indicators were consistent with economic activity in the eurozone gaining traction,
still led by Germany but also with a better outlook in the periphery
Our MICA-BBVA model projects quarterly GDP growth of around 0.4% q/q in 1Q14.
Our MICA-BBVA model projects quarterly GDP growth of around 0.4% q/q in 1Q14.
EZ: real GDP growth and forecasts based on MICA-BBVA model (%, QoQ)Source: BBVA ResearchCurrent forecast: 4th December
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
1Q
09
2Q
09
3Q
09
4Q
09
1Q
10
2Q
10
3Q
10
4Q
10
1Q
11
2Q
11
3Q
11
4Q
11
1Q
12
2Q
12
3Q
12
4Q
12
1Q
13
2Q
13
3Q
13
4Q
13
1Q
14
Series9 Series3 Series4 MICA-BBVA GDP observedCI 20% CI 40% CI 60%
Foreign Exchange Contact Group
6 May 2014
Page 13
Positive external environment, but with doubts onthe impact from both China and exchange rate
-0.45
-0.40
-0.35
-0.30
-0.25
-0.20
-0.15
-0.10
-0.05
0.00
GDP Exports
2014 2015
Impact of strong euro on GDP and exports* (pp)Source: BBVA Research
* Estimated impact of new projection for the EURUSD (average 2014 = 1.35) vs previous projection, i.e EURUSD +4% higher than previously
expected in 2014
Impact of strong euro on inflation* (pp)Source: BBVA Research
-0.45
-0.40
-0.35
-0.30
-0.25
-0.20
-0.15
-0.10
-0.05
0.00
2014 2015
Foreign Exchange Contact Group
6 May 2014
Page 14
Financial markets
Macroeconomic outlook
Inflation expectations
Fragmentation and its impact on monetary policy: a comment on forward guidance
Some preliminary remarks on QE
Issues for discussion: challenges
Contents
Foreign Exchange Contact Group
6 May 2014
Page 15
Inflation in the eurozone: baseline scenarioSource: BBVA Research
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Dec-08
Sep-09
Jun-10
Mar-11
Dec-11
Sep-12
Jun-13
Mar-14
Dec-14
20% 40% 60% 95%
Inflation: slow increase in the forecast horizon and narrow risk of deflation in our baseline scenario
The decline in headline inflation over 1Q14 accumulated in the more volatile components; core inflation remained stable
Downward pressures stem from the euro’s appreciation and low raw material prices
The current recovery in demand, the muted financial stress and the repaired banking lending channel reduce deflation risks
Foreign Exchange Contact Group
6 May 2014
Page 16
Measuring trend inflation through alternativemeasuresEurozone: inflation (% YoY)Source: BBVA Research
-3
-2
-1
0
1
2
3
4
5
6
Mar-
04
Sep
-04
Mar-
05
Sep
-05
Mar-
06
Sep
-06
Mar-
07
Sep
-07
Mar-
08
Sep
-08
Mar-
09
Sep
-09
Mar-
10
Sep
-10
Mar-
11
Sep
-11
Mar-
12
Sep
-12
Mar-
13
Sep
-13
Mar-
14
CI95 CI80 CI60
CI40 CI20 Optimal trim
Headline (official) Core (official)
1. We compute 2,601 symmetric and asymmetric trimmed means for the EZ using
the weighted distribution of the CPI subclasses (95 for EZ)
1. We compute 2,601 symmetric and asymmetric trimmed means for the EZ using
the weighted distribution of the CPI subclasses (95 for EZ)
3. Finally, we constructed CI around the optimum trimmed-mean selected using the
predictive capacity test proposed by Diebold and Mariano (1995)
3. Finally, we constructed CI around the optimum trimmed-mean selected using the
predictive capacity test proposed by Diebold and Mariano (1995)
2. We then selected the “optimum” trimmed-mean based on its predictive capacity with respect to annualized mean inflation over a
forecast horizon of 30 months
2. We then selected the “optimum” trimmed-mean based on its predictive capacity with respect to annualized mean inflation over a
forecast horizon of 30 months
Measuring trend inflation through trimmed-means, methodology
Trend inflation in the EZ is trending downwards and currently is well below the
target, at 1%.
Foreign Exchange Contact Group
6 May 2014
Page 17
Measuring trend inflation through alternativemeasuresEurozone: inflation (% YoY)Source: BBVA Research
1. The model is able to discriminate transitory from permanent deflationary episodes
1. The model is able to discriminate transitory from permanent deflationary episodes
3. In the EZ the main caveat is the limited sample, which implies to take some
assumptions: with and without variance change in inflation
3. In the EZ the main caveat is the limited sample, which implies to take some
assumptions: with and without variance change in inflation
2. Inflationary pressures are embedded in the performance of some macro variables (GDP,
investment ratio, unemployment rate and inflation)
2. Inflationary pressures are embedded in the performance of some macro variables (GDP,
investment ratio, unemployment rate and inflation)
Measuring trend inflation as a latent variable, methodology
Trend inflation in the EZ is trending downwards (more rapidly if a break of inflation volatility is
considered) and currently is well below the target, at 1.5% (or 1%).
-1.0
0.0
1.0
2.0
3.0
4.0
1997
1999
2001
2003
2005
2007
2009
2011
2013
Headline Core
Trend Trend with break in volatility
*For more details see Annex 1 and http://www.bbvaresearch.com/KETD/fbin/mult/1405_Global_Economic_Outlook_tcm348-448754.pdf?ts=1252014
Foreign Exchange Contact Group
6 May 2014
Page 18
Deflation probability is quite low in the EZ, but less so in the periphery
0
5
10
15
20
25
30
35
mar-
08
jun
-08
sep
-08
dic
-08
mar-
09
jun
-09
sep
-09
dic
-09
mar-
10
jun
-10
sep
-10
dic
-10
mar-
11
jun
-11
sep
-11
dic
-11
mar-
12
jun
-12
sep
-12
dic
-12
mar-
13
jun
-13
sep
-13
dic
-13
mar-
14
3 consecutive months
6 consecutive months
9 consecutive months
12 consecutive months
Eurozone: proxy for deflation risk(% CPI items with persistently negative MoM swda growth rates)Source: BBVA Research based on INE
0
5
10
15
20
25
30
35
mar-
08
jun
-08
sep
-08
dic
-08
mar-
09
jun
-09
sep
-09
dic
-09
mar-
10
jun
-10
sep
-10
dic
-10
mar-
11
jun
-11
sep
-11
dic
-11
mar-
12
jun
-12
sep
-12
dic
-12
mar-
13
jun
-13
sep
-13
dic
-13
mar-
14
3 consecutive months 6 consecutive months
9 consecutive months 12 consecutive months
Spain: proxy for deflation risk(% CPI items with persistently negative MoM swda growth rates)Source: BBVA Research based on INE
Foreign Exchange Contact Group
6 May 2014
Page 19
EZ: even though one should not read too much from these numbers, long-term inflation expectations are not low
2Y Inflation swap (spot rates %) Source: Bloomberg, ECB and BBVA Research
• Short-term inflation expectations: quite sensitive to negative surprises in inflation. • Long-term inflation expectations: more stable and above the target, but still trending downwards
Eurozone inflation expectations implicit in bond markets (%)*Source: Bloomberg and BBVA Research
0,0
0,5
1,0
1,5
2,0
2,5
3,0
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14
EU FR Ger SPF 2Y ahead SPF (2015)
1,5
2,0
2,5
3,0
3,5
4,0
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14
5Y5Y inflation Swap
2Y2Y inflation Swap*GDP-weighted average of separately estimate breakeven rates for France and
Germany
Foreign Exchange Contact Group
6 May 2014
Page 20
Inflation surprises affect short-term inflation expectations
Impact on inflation expectations* Change in five-day rolling average (daily data, bps)Source: Bloomberg and BBVA Research
A simple case study indicates that, on average, market-based inflation expectations react to surprises in inflation, a pattern that is more evident since 2013.
-8,0
-6,0
-4,0
-2,0
0,0
2,0
4,0
6,0
8,0
1Y infl.Swap
2Y infl.Swap
3Y infl.Swap
1Y1Y fwdinfl. Swap
2Y2Y fwd.infl. Swap
5Y5Y fwd.infl. Swap
5Y5Y fwd.Breakeven
Impact on Flash HCPIChange in five-day rolling average (daily data, bps)Source: Bloomberg and BBVA Research
* Simple average of German and French inflation expecations. From Jan 2013 up to now.
** Significance largely driven by a small number of large surprises in inflation
Downside
surprises on
Inflation
Upside
surprises on
Inflation
Inflation surpises
Statistical
significance**
1Y infl. Swap -7,2 -0,1 YES
2Y infl. Swap -5,2 3,3 YES
3Y infl. Swap -4,1 2,4 YES
1Y1Y fwd infl. Swap -3,2 6,2 NO
2Y2Y fwd. infl. Swap 2,8 3,1 NO
5Y5Y fwd. infl. Swap -0,1 -0,8 NO
5Y5Y fwd. Breakeven 2,8 3,0 NO
Foreign Exchange Contact Group
6 May 2014
Page 21
Financial markets
Macroeconomic outlook
Inflation expectations
Fragmentation and its impact on monetary policy: a comment
on forward guidance
Some preliminary remarks on QE
Issues for discussion: challenges
Contents
Foreign Exchange Contact Group
6 May 2014
Page 22
Fragmentation remains above pre-crisis levels. A fresh impulse is needed.
Composite measure of eurozone financial fragmentation*Source: BBVA Research and Bloomberg
0,0
1,0
2,0
3,0
4,0
5,0
6,0
Jun-
09
Dec
-09
Jun-
10
Dec
-10
Jun-
11
Dec
-11
Jun-
12
Dec
-12
Jun-
13
Dec
-13
*For more details see Annex and http://www.bbvaresearch.com/
Foreign Exchange Contact Group
6 May 2014
Page 23
Fragmentation: implications for monetary policy.
Conventional policy is less effectiveas the monetary-policy transmission is curtailed.
Conventional policy is less effectiveas the monetary-policy transmission is curtailed.
Under “normal” conditions
It generates unwanted (asymmetric) risksIt generates unwanted (asymmetric) risks
Forward guidance (FG) seen as an “optimal commitment device”
as there is no room left for conventional policy
Does fragmentation affect FG?
Forward guidance (FG) seen as an “optimal commitment device”
as there is no room left for conventional policy
Does fragmentation affect FG?
Under the zero-lower-bound restriction
Under the zero-lower-bound restriction
ECB. FXCP, My 2014
Page 24
Fragmentation calls for the strengthening of FG
Interest rates under different policy rulesSource: BBVA Research
*Fragmentation is modeled by a lower interest rate elasticity in the IS curve
Under models of optimal policy under commitment, fragmentation imposes the need for lower rates for a longer time: forward guidance should be reinforced.
Under models of optimal policy under commitment, fragmentation imposes the need for lower rates for a longer time: forward guidance should be reinforced.
-6
-4
-2
0
2
4
Output Inflation
Optimal rule, commitment Taylor rule
Output gains/losses and inflation in the medium term*Source: BBVA Research
*Cumulative output gains/losses relative to equilibrium.
For more details see Annex and http://www.bbvaresearch.com/KETD/fbin/mult/140506_Europe_Economic_Watch_tcm348-448578.pdf?ts=1252014
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
timetimetimetime
Optimal Taylor
Commitment
Commitment with fragmentation
Foreign Exchange Contact Group
6 May 2014
Page 25
Financial markets
Macroeconomic outlook
Inflation expectations
Fragmentation and its impact on monetary policy: a comment on forward guidance
Some preliminary remarks on QE
Issues for discussion: challenges
Contents
Foreign Exchange Contact Group
6 May 2014
Page 26
QE: main channels by which QE may alter real rates
Signalling channel Signalling channel Signalling channel Signalling channel
Targeting channelTargeting channelTargeting channelTargeting channel
Liquidity channelLiquidity channelLiquidity channelLiquidity channel
Credit channelCredit channelCredit channelCredit channel
Inflation channelInflation channelInflation channelInflation channel
Conclusions from recent Conclusions from recent Conclusions from recent Conclusions from recent
experiencesexperiencesexperiencesexperiences
QE announcements “postpone” date of first
rate hike by around 4 to 6 months.
In In In In QE1QE1QE1QE1, it explained between 50% and , it explained between 50% and , it explained between 50% and , it explained between 50% and
70% 70% 70% 70% of the reduction in 10Y Treasury reduction in 10Y Treasury reduction in 10Y Treasury reduction in 10Y Treasury
yieldsyieldsyieldsyields.
The only channel to raise rates (liquidity
premium).
Large impact on riskier bondsLarge impact on riskier bondsLarge impact on riskier bondsLarge impact on riskier bonds, with a
multiplier effect through the strengthening
of the financial sector´s balance sheets.
QEs´ efficacy on this front remains a topic
of heated debate.
Main caveats Main caveats Main caveats Main caveats
in the EZin the EZin the EZin the EZ
• Can it help reduce Can it help reduce Can it help reduce Can it help reduce
fragmentation?fragmentation?fragmentation?fragmentation?
• HowHowHowHow relevantrelevantrelevantrelevant isisisis
moral moral moral moral hazardhazardhazardhazard????
• Enough support?
Foreign Exchange Contact Group
6 May 2014
Page 27
QE: heterogeneous impact on yields (from steadystate).
assets
channels
12
Month
interest rate
2Y
bond yield
Core
2Y
bond yield
Periph.
10Y
bond yield
Core
10Y
bond yield
Periph.
Corp.
BBB
Corp.
AAA
Signaling 0 - - - - 0 0 - -
Targeting 0 0 0 - - - - - - - 0 - - - -
Liquidity +/0 + + 0 + + 0 0 +
Credit 0 0 - 0 - - - - - - - 0
Inflation 0 - - 0 0 -/0 -/0
RANKING
1: higher impact
6. Lower impact
6 5 3 4 1 2 3
Potential impact QE on (European) assets through diffierent channelsSource: BBVA Research
Foreign Exchange Contact Group
6 May 2014
Page 28
QE simulation: impact would depend on size and composition of purchases.
Furhter impact on yields would alsodepend on how much of a surprise is
the ECB announcement.
Furhter impact on yields would alsodepend on how much of a surprise is
the ECB announcement.
Impact would be significant onperipheral bonds (reduction of around -
60/200 bps), less so on the Bund.
Impact would be significant onperipheral bonds (reduction of around -
60/200 bps), less so on the Bund.
For any particular bond, the targetingchannel grows in importance the more is purchased by the ECB (relative to its
total amount outstanding).
For any particular bond, the targetingchannel grows in importance the more is purchased by the ECB (relative to its
total amount outstanding).
Amount of 10Y sovereing bonds widheld by official entities.(% of total outstanding)
0
10
20
30
40
50
60
70
80
90
Current amount owned by official entities (incl. foreign)
QE purchases of EUR 1 trillion according to capital keys
• We estimate the impact on sovereign yields through a panel assuming that a one-trillion QE would only be used for buying government bonds according to ECB’s capital key*.
* For more details see Annex and http://www.bbvaresearch.com/
Foreign Exchange Contact Group
6 May 2014
Page 29
QE simulation: CB balance sheets have been an important driver of FX
Relative monetary policy stance1 vs EUR-USD1 Relation between Fed and ECB central bank assets, ratio Fed/ECBSource: Bloomberg and BBVA Research
1,00
1,10
1,20
1,30
1,40
1,50
1,60
1,70
0,4
0,6
0,8
1,0
1,2
1,4
1,6
1,8
2,0
2,2
Jan-0
8
Ju
l-0
8
Jan-0
9
Ju
l-0
9
Jan-1
0
Ju
l-1
0
Jan-1
1
Ju
l-1
1
Jan-1
2
Ju
l-1
2
Jan-1
3
Ju
l-1
3
Jan-1
4
Relative monetary policy stance EUR-USD (rhs)
0
100
200
300
400
500
600
Jan
-07
Jul-0
7
Jan
-08
Jul-0
8
Jan
-09
Jul-0
9
Jan
-10
Jul-1
0
Jan
-11
Jul-1
1
Jan
-12
Jul-1
2
Jan
-13
Jul-1
3
Jan
-14
Jul-1
4
BCE FED
• With short rates approaching the ZLB, central banks began to pursue less conventional monetary policies—
including (QE)—to stimulate economic growth. This has led in to significant increase in their balance sheets
which has have been an important driver (a significant variable in FX models) of currencies over recent years.
• If the ECB embarks in a QE of 1 trillion (one year time program and at the same time the Fed continues with
the tapering) this would depreciate the euro by around 8%
Fed and ECB balance sheetIndex Jan 2007=100Source: Bloomberg and BBVA Research
* See Annex 3 for more details
Foreign Exchange Contact Group
6 May 2014
Page 30
Financial markets
Macroeconomic outlook
Inflation expectations
Fragmentation and its impact on monetary policy: a comment on forward guidance
Some preliminary remarks on QE
Issues for discussion: challenges
Contents
Foreign Exchange Contact Group
6 May 2014
Page 31
Output gap (% of Potential GDP)Source: BBVA Research
Challenges ahead: the eurozone cycle lags behind the US cycle
-4,0
-3,0
-2,0
-1,0
0,0
1,0
2,0
3,0
4,0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
USA EMU
Foreign Exchange Contact Group
6 May 2014
Page 32
Challenges ahead: the Fed will eventually tighten
4Q14
Expected
End QE3
3Q15
First FFR Hike
1H16
Policy NormalizationBalance sheet: let securities
mature/sales
Expected Timeline for Fed Exit Strategy
The probability of
early rate hike has
recently increased
12-month ahead fed funds and 10-year Treasury yieldsSource: Bloomberg and BBVA Research
0,05
0,10
0,15
0,20
0,25
0,30
0,35
1,2
1,6
2,0
2,4
2,8
3,2
3,6
Jan
-13
Mar-
13
May-1
3
Jul-1
3
Sep
-13
No
v-1
3
Jan
-14
Mar-
14
May-1
4
10YT (lhs) 12-month ahead fed funds
Foreign Exchange Contact Group
6 May 2014
Page 33
10Y bond yield: US and GER, % Source: Bloomberg and BBVA Research
1y1y forward OIS in the EUR and USD marketsSource Bloomberg and BBVA Research
-60
-40
-20
0
20
40
60
80
100
120
140
1
1,5
2
2,5
3
3,5
Spread US-Germany (rhs) Germany 10Y yield US 10Y yield
0
0,1
0,2
0,3
0,4
0,5
0,6
0,7
0,8
May-1
3
Jun
-13
Jul-1
3
Au
g-1
3
Se
p-1
3
Oct
-13
No
v-1
3
Dec-1
3
Jan
-14
Feb
-14
Mar-
14
Ap
r-1
4
May-1
4
EUR 1y1y fwd OIS USD 1y1y fwd OIS
ECB FG
Rate cut
Jan ECB meeting
Mar. ECB
meeting
Mar. FOMCmeeting
Challenges ahead: will the EUR-rate decoupling persist?
Foreign Exchange Contact Group
6 May 2014
Page 34
-0,5
-0,4
-0,3
-0,2
-0,1
0
0,1
1,2
1,22
1,24
1,26
1,28
1,3
1,32
1,34
1,36
1,38
1,4
Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14
EURUSD (lhs) Rate differential (rhs)
2-year interest rate differential* vs EURUSD* German Bunds – US Treasuries, %Source: Bloomberg, EPFR and BBVA Research
Challenges ahead: will the Fed´s exit be enough to curb the euro strength?
Recent market developments.
Jorge Sicilia, Chief Economist BBVA
Foreign Exchange Contact Group
Frankfurt, 6 May 2014
Foreign Exchange Contact Group
6 May 2014
Page 36
Annex 1: Measuring trend inflation as a latent variable
Results for Europe. No volatility breaks
Due to the limited sample, we estimate a model with none volatility breaks.
DLM - Estimation by BFGS
Convergence in 27 Iterations. Final criterion was 0.0000000 <= 0.0000100
Quarterly Data From 1995:01 To 2013:04
Usable Observations 76
Rank of Observables 297
Log Likelihood 1317.4923
Concentrated Variance 5.5057e-004
Variable Coeff Std Error T-Stat Signif
************************************************************************************
1. PHI_U 0.656675840 0.085056567 7.72046 0.00000000
2. BETA_X -0.679675941 0.165404375 -4.10918 0.00003971
3. MU_PI1 0.631668389 0.065884436 9.58752 0.00000000
4. PHI_0 -0.210063876 0.040683286 -5.16340 0.00000024
5. BETA_Y1 1.231126294 0.216626628 5.68317 0.00000001
6. BETA_Y0 -0.069303323 0.236909599 -0.29253 0.76988091
7. ETA_Y 0.238879843 0.062039824 3.85043 0.00011791
8. THETA_1 0.948325331 0.021130490 44.87948 0.00000000
9. THETA_2 0.385501619 0.021588704 17.85664 0.00000000
10. GAMMA_Y 0.003615491 0.000434267 8.32550 0.00000000
11. SIG_NU_U 0.000181595 0.000268670 0.67590 0.49910235
12. SIG_NU_X -0.010172746 0.004327531 -2.35070 0.01873792
13. SIG_OMEGA_GAMMA 0.025620424 0.010378429 2.46862 0.01356342
14. SIG_OMEGA_U 0.012883349 0.006042958 2.13196 0.03301008
15. SIG_OMEGA_X 0.014680209 0.005236606 2.80338 0.00505696
16. SIG_NU_PI2 0.009308235 0.005397659 1.72449 0.08461852
Foreign Exchange Contact Group
6 May 2014
Page 37
We try to test and estimate a volatility break in inflation after the financial crisis.
DLM - Estimation by BFGS
Convergence in 2 Iterations. Final criterion was 0.0000000 <= 0.0000100
Quarterly Data From 1995:01 To 2013:04
Usable Observations 76
Rank of Observables 297
Log Likelihood 1309.6869
Concentrated Variance 1.3170e-003
Variable Coeff Std Error T-Stat Signif
************************************************************************************
1. PHI_U 0.626811352 0.036309212 17.26315 0.00000000
2. BETA_X -0.220359969 0.073325199 -3.00524 0.00265370
3. MU_PI1 0.548779791 0.067969085 8.07396 0.00000000
4. PHI_0 -0.194138919 0.024525125 -7.91592 0.00000000
5. BETA_Y1 0.615486351 0.081020050 7.59672 0.00000000
6. BETA_Y0 0.166421302 0.082005132 2.02940 0.04241746
7. ETA_Y 0.203964105 0.046800230 4.35819 0.00001311
8. THETA_1 0.963710169 0.022925514 42.03658 0.00000000
9. THETA_2 0.343998809 0.029412153 11.69580 0.00000000
10. GAMMA_Y 0.003511292 0.000358076 9.80600 0.00000000
11. SIG_NU_U1 0.000075424 0.000036338 2.07564 0.03792728
12. SIG_NU_X1 0.000061393 0.000508807 0.12066 0.90396038
13. SIG_NU_U2 0.000055382 0.000094203 0.58790 0.55660205
14. SIG_NU_X2 0.001188461 0.001680238 0.70732 0.47936959
15. SIG_OMEGA_GAMMA 0.006901673 0.001657759 4.16326 0.00003137
16. SIG_OMEGA_U 0.003930774 0.000980551 4.00874 0.00006104
17. SIG_OMEGA_X 0.003772815 0.000873977 4.31683 0.00001583
Annex 1:Measuring trend inflation as a latent variable
Results for Europe. Volatility breaks in inflation
With volatility break in inflation, the model modifies the signal/noise ratio
ECB. FXCP, My 2014
Page 38
• In order to monitor the financial fragmentation in the euro area, we constructed a composite measure of
euro area financial fragmentation. The advantage of utilizing such index is the ability to monitor, on a
monthly basis, more accurately the evolution of financial fragmentation.
• The FFI is constructed using principal component analysis, a statistical method of extracting factors
responsible for the co-movement of several variables. We assume that financial fragmentation is the
primary factor influencing this co-movement, and by extracting this factor (the first principal component)
we are able to create an index.
• The components are:
o the interquartile range of euro area countries* two-year government bond yields ,
o the cross-country dispersion (specifically, the coefficient of variation: the ratio of the standard
deviation to the mean) of bank lending rates to corporates and households (average),
o the gross liquidity provision by the Eurosystem as a share of bank assets, and
o the Target 2 balances surplus.
• To combine these varied indicators**, we calculate a Z-score for each, and then estimate the first
principal component of these Z-scores.
* Ireland, Spain, Germany, Italy, France, Netherlands, Portugal, Greece, Belgium, Finland and Austria.
** Data: monthly frequency. Sources: National Central Banks, ECB and Bloomberg
Annex 2: Fragmentation
Financial fragmentation index, BBVA Research
ECB. FXCP, My 2014
Page 39
*Clarida, R., J. Gali and M. Gertler: The Science of Monetary Policy: A New Keynesian Perpective.
Additional literature:
• Campbell, J., C. Evans, J. Fisher and A. Justiniano: Macroeconomic Effects of Federal Reserve Forward Guidance.
• English W., J. Lopez-Salido and R. Tetlow: The Federal Reserve's Framework for Monetary Policy--Recent Changes and New Questions.
• Woodford, M.: Methods of Policy Accommodation at the Interest-Rate Lower Bound.
Annex 3: On forward guidance
A simple model (Clarida, Gali, Gertler*)
ECB. FXCP, My 2014
Page 40
*Serkan Arslanalp and Tigran Poghosyan: Foreign Investor Flows and Sovereign Bond Yields in Advanced Economies
The paper employs a panel data methods to analyze the relationship between the foreign investor base of sovereign debt, and
long-term sovereign bond yields in advanced economies (Aes*). The model uses a quarterly investor base dataset for 22 Aes over
Q12004‒Q32013. The specification includes the standard macroeconomic determinants of long-term sovereign bond yields (short-
term bond yields, GDP growth, CPI inflation, Debt-to-GDP ratio.).The paper also control for the domestic central bank purchases of
government debt. In addition, they introduce the foreign investor base variable (breakdown in share of official foreign debt and the
share of private foreign debt) as an additional determinant of long-term sovereign bond yields. Estimations are performed using the
fixed effects estimator.
* Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Korea, the Netherlands, New Zealand,
Portugal, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
Annex 4: QE simulation
QE simulation on peripheral bonds (Arslanalp and Poghosyan*)