Global Implications of Europe’s RedesignColumbia-EIB-SG-SUERF Conference in NYC, 10.6.16

Marc-Olivier Strauss-KahnDirector general, Economics and International

Banque de France

European Monetary Policy and Implications for US Markets

Panel Discussion

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Part 1: How to assess the EA MP compared to the US MP at the ZLB?

- There is a EA-US yield decoupling now larger & longer than in the mid-2000s

- It can be largely explained by ≠ R stars, expected accommodation & fundamentals

Part 2: Is there an impact of the EA MP on the US?

- Little literature about EA MP effects on US markets (≠ large US MP effects on RoW)

- Event graphs suggest some EA MP spillovers: not more since 2014 on US yields but

slightly + on equity & XR (even if XR related to oil price changes & not an objective)

Concluding paradox on the financing of both economies:

despite lower risk-free rates, the Cost of Equity remains ± stable/high

Main messages on EA vs. US Monetary Policies (MP)

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Monetary Policy at the Z.L.B. or ‘‘in a Z.G.E.”?

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“’’

Part 1: now a larger/longer decoupling than in the mid-2000s

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1st decoupling 2004m11: 2 years before & after2nd decoupling 2013m04: 2 years before and …

Spread 10 years GER-US > 50 bps

1… Why a decoupling? The possible role of R star (neutral rate)

Persistent differences in future short-term

interest rates may reflect different R stars

In 2015 (Holston …): EA = - 0.5% ; US = + 0.4%

(estimates surrounded by uncertainty but

now clearly lower in the EA than in the US)

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Source : Holston, Laubach & Williams (2016)

Deeper decrease in the EA may be due to:- lower productivity growth;- lower working population growth …

Source: Constancio (2016)

1… The role of CB Communication: expected accommodation

In line with ECB communication, APP has been expected to grow

EA low yields reflect that marketparticipants price a persistent stimulus from the Eurosystem

According to markets in Sept. 2016, the risk of ECB tapering hasn’t (yet) been the dominant scenario …

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Source : Arrata-Nguyen (BDF, 2016)

Let’s assume basic Taylor Rules (TR),

leaving aside ≠ in R stars; forecasts allow

us to derive a TR differential (in bp):

in 2016 ≈ 120; in 2017 ≈ 70; in 2018 ≈ 30

Thus, over the next 3 years, the average

TR differential ≈ 73bp while the 3y DE-

US spread is ≈ 150 bp

=> Fundamentals would account for half

of the 3y spread observed today

Taylor Rate = TR 2016 2017 2018

EA: HICP 0.2 1.2 1.6

HICP – target (1.9) -1.7 -0.7 -0.3

GDP 1.7 1.6 1.6

Δ GDP potential 0.2 0.1 0.1

Impact on basic TR -2.5 -1.0 -0.4

US: PCE 1.3 1.9 2

PCE – target (2.0) -0.7 -0.1 0

GDP 1.8 2.0 2

Δ GDP potential -0.5 -0.3 -0.3

Impact on basic TR -1.3 -0.3 -0.1

TR differential -1.2 -0.7 -0.3

Forecasts based on ECB’s MPE and on the FOMC, both in September 2016Basic TR: coefficients on infl. / GDP = 1.5 / 0.5 (same in EA & US); potential growth: 1.5% in EA & 2.25% in the US

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1… Why a larger/longer decoupling? The role of fundamentals

Part 1: How to assess the current EA Monetary Policy (MP)?

- The EA’s yield decoupling with the US is larger & longer than in the mid 2000s

- It can be explained by R star, expected accommodation & fundamentals

Part 2: Is there an impact of the EA MP on US markets?

- Little literature about EA MP effects on US markets (≠ large US MP effects on RoW)

- Event graphs suggest some EA MP spillovers: not more since 2014 on US yields but

slightly + on equity & XR (even if XR related to oil price changes & not an objective)

Concluding paradox on the financing of both economies:

Despite lower risk-free rates, the Cost of Equity remains ± stable/high

Main messages on EA vs US Monetary Policies

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Part 2: EA/US short-term yield correlation & US conundrum

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Rolling correlations (1-m windows) for 3Y zero coupon yields DE & US

Even if there is decoupling, there is currently a US conundrum;

Similar trends in markets’ inflation expectations despite different inflation forecasts.

Does EA MP contribute to the decline in the US yield curve?

Many studies published about the US impact on the RoW: on EMEs > on AEs, with similar channels for MP & Unconventional MP

Less is written on the impact of EA UMP (recently implemented only):

- Smaller spillovers (if any) than from the US MP: Rogers …, 2014 (2007-2013, VAR)

- Positive impact on US equities & confidence but less on 10y sovereign Rogers …, 2014 (2007-2013, VAR) ; Fratzscher …, 2016 (2007-2012, Panel)

- Via SMP=portfolio rebalancing; OMT=confidence; APP=signal: Georgiadis 2015

Caveat: this literature relies on econometric tools that provide averaged results over the samples, and cannot bring strong insights on what happened recently (except when models include Time-Varying parameters)

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2.1. Literature survey on MP effects on Financial Markets

US sovereign conundrum, although U ↘, core CPI ↗ & Fed tightening

Do EA MP spillovers play a role?

- according to Goldman Sachs, ECB QE accounts for ≈ 1/3 of the 10y rate drop, => higher asset prices & stronger USD since the end of 2013

- Large EA spillover on US long-term inflation expectations: Ciccarelli …, 2015

- Weaker EA prospects & easier financial conditions => downward trend in LT US yields: Buitron …, 2015

- APP boosted global markets & $, but no effect on US bonds (Georgiadis …, 2015)

- Markets view US bond yields as ‘anchored’ by EA yields (K. Guha, Sept. 2016)

=> Diverging results may be complemented by BDF work in progress …

2.1… Literature survey on recent EA MP

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2.2. Event graphs: effects of EA MP on US sovereign rates

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ECB Governing Councils’ Announcements & Daily Changes in 10Y rates

Some spillovers but no evidence that the

US yield reaction is systematically larger as

of mid 2014. If anything, there is more

upward impact (62% vs 53% before)

Jan. 2010 - May 2014: 53 GC

Jun. 2014 - Aug. 2016: 21 GC

Method: distribution of changes in the 10Y

zero coupon yield observed between the:

- Wed. cob before an ECB Gov. Council

- Thur. cob of that ECB GC (both in US time)

Nota: expected changes already discounted

In annex, for inflation expectations, the outcome is broadly similar

On average: +0.02% after 06-2014+0.01% before

BDF calculus by Ph. Andrade & al.

-2

-1

0

1

2

3

-3%

-2%

-1%

0%

1%

2%

3%

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2.2... EA links with US Market: exchange rate & equities

… exchange rates ($/€)

… equity prices (S&P 500)

more ↓ impact (62% vs 51% before), and larger (avg: -0.16% vs -0.06%), but 1 large upward as well (on Dec. 2015)

more extremes and > 0 … recently (avg: +0.17% vs +0.08 before)

Governing Councils’ announcements & daily rate of change in …

Jan. 2010 - May 2014: 53 GC Jun. 2014 - Aug. 2016: 21 GC%

Euro Dollar Bilateral Exchange Rate (rhs) and oil prices (lhs)

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2.2… Yet $/€ level is not an objective & is affected by oil prices

0

100

200

300

400

500

600

0

2

4

6

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2008 2009 2010 2011 2012 2013 2014 2015

Buybacks (BLN) CoE (US)

Risk-free rate (T-Bill 10Y)

0

2

4

6

8

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2009 2010 2011 2012 2013 2014 2015 2016CoE (Germany) Risk-free rate (Bund 10Y)

Stable CoE for German firmsversus lower risk-free rate

Source: Bloomberg, Datastream. BDF estimates

Concluding paradox: Cost of Equity (CoE) of Non fin. Corporates

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Stable US CoE versus increasing share buybacks

Despite low(er) risk-free rates, CoE have remained ± stable & high across the Atlantic

APPENDIX

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2.1. Literature on Monetary Policy effects on Financial Markets

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Literature focuses on US MP impact on RoW. Its main results are:

- Large spillovers of US -> RoW but less on AEs (Fratzscher..., 2013 (2007-10,

Regressions) ; Bowman..., 2014 (2006-2013, Panel) ; Miranda-Aggripino and Rey, 2015 (1980-2010, Factor

Model + BVAR))

- Similar channels of MP & UMP (Dd, XR, fin. conditions, K flows)

- Dilemma vs trilemma, notably for EMEs (Rey, 2015 (1990-2012, Factor model + VAR) ;

Dedola…, 2015 (1980-2013, BVAR) vs XR regime still matters (Aizenman …, 2015 (1986-2012, regress.)

Figure : Cumulated impact of US QE for equity prices (source : Fratzscher et al. 2013)

2.2... EA links with US Market: inflation expectations

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ECB Governing Council announcements & daily changes in …

… ILS 1Y in 1Y

… ILS 5Y in 5YLess extreme after 06.14, exp. on the positive side -> average: +0.12% after vs +0.34% before

%

Jan. 2010 - May 2014: 53 GC

Jun. 2014 - Aug. 2016: 21 GC

Same frequency of up/down in the two periods for both variables

avg: -0.24% after vs -0.19% before

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Geographical contributions to the USD NEER appreciation2 periods in the drivers of USD appreciation since mid-2014:

1/ Jul. 14 – Apr. 15: differential in MP expectations

2/ Since May 15: Downward revision in macro fundamentals for EMEs

Does Monetary Policy Accomodation have Detrimental Effectson the Banking System?

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