Draghi Outshines Yellen at Jackson Hole

Financial markets commentary Aug. 21-27

European Central Bank president Mario Draghi stole the show at the Jackson Hole central bankers’ conference on Aug. 22, igniting speculation of an impending quantitative easing program in the eurozone.
Draghi Outshines Yellen at Jackson Hole
Rahul Vaidyanath

European Central Bank president Mario Draghi stole the show at the Jackson Hole central bankers' conference on Aug. 22, igniting speculation of an impending quantitative easing program in the eurozone.

The conference, which focused on labor markets, was a highly anticipated event with U.S. Federal Reserve chair Janet Yellen being the center of markets' attention in the lead-up.

However, the implications of Draghi's speech and ongoing weak economic data readings pushed bond yields to record lows in a number of eurozone markets, while European stock markets moved higher and the euro continued its August nosedive. All signs in financial markets point to a "pricing in" of asset purchases of one kind or another by the ECB.

"I am confident that the package of measures we announced in June will indeed provide the intended boost to demand, and we stand ready to adjust our policy stance further," Draghi said.

Could Draghi be using some more "verbal intervention," which worked beautifully in July 2012? Back then, his "whatever it takes" speech led markets to believe the ECB would buy bonds of troubled eurozone countries (such as Spain and Italy) if their yields kept rising.

After his speech, this "eurozone break-up" premium in bond yields gradually vanished, and now Spain's 10-year yield (2.14 percent, an all-time low) is lower than that of the U.S. (2.36 percent). Italy's yield is 2.39 percent, also an all-time low.

Improving Macro Background

Geopolitical risks appear to have now faded, with a Gaza ceasefire taking hold while Russia's Vladimir Putin and Ukraine's Petro Poroshenko have talks.

Meanwhile, the U.S. economy keeps humming along, showing the strongest consumer confidence in seven years and robust durable goods orders. The S&P 500 broke the psychological 2,000 barrier, while the Dow pushed over 17,000.

But U.S. bond yields moved lower in the observation period. The difference between U.S. bond yields and German bond yields reached the highest levels since 1999, and expectations of quantitative easing in the eurozone will see other markets (U.S. treasuries, for example) benefiting. As investors seek higher yields, they could move to buy U.S. treasuries, thus pushing those yields lower.

Another factor boosting North American economies in August has been the falling price of oil. But despite this and the price of gold also falling in August, Canadian stocks have risen nearly 15 percent this year making it one of the top-performing developed equity markets in 2014.

Bank of Canada governor Stephen Poloz made it clear at Jackson Hole that Canada does not have to raise rates in tandem with what the U.S. Fed might do sometime next year.

His comments were driven by continuing slack in the labor markets and the high percentage of part-time jobs being created.

"We're confident there's quite a bit of room to grow and, particularly since our interest rates are already at 1 percent, we figure we've got time to watch this unfold," Poloz said, as reported by Bloomberg.

These dovish remarks also bode well for Canadian equities.

Of note in Canadian markets, the loonie got a boost from Burger King's purchase of Tim Hortons, moving upward by roughly 0.5 cent—its biggest upward move since June.

When a foreign company intends to purchase a Canadian company, it needs Canadian dollars to complete the transaction, thus increasing demand and the value of the loonie.

The first week of a month is always a particularly interesting one for financial markets, especially given the world we live in where central banks own centre stage. The ECB, Bank of England, and Bank of Japan will be making their rate decisions on Sept. 4, a day after the Bank of Canada makes its own announcement. The U.S. jobs report (non-farm payrolls) will be released on Sept. 5—plenty of information for financial markets to chew on.

Rahul Vaidyanath is a Chartered Financial Analyst (CFA) with over 15 years of capital markets experience. He has worked in the Financial Markets Department at the Bank of Canada as Principal Trader, Foreign Reserves Management. He has also worked as a mortgage bond trader in the U.S.

Changes in Key Financial Market Variables

  20-Aug 27-Aug Change
TSX 15,561.95 15,602.65 0.3%
CAD/USD 0.9112 0.9208 1.1%
Cdn 2yr yield 1.09% 1.10% 0.01%
Cdn 5yr yield 1.56% 1.53% -0.03%
Cdn 10yr yield 2.10% 2.01% -0.09%
S&P 500 1,986.51 2,000.12 0.7%
Dow 16,979.13 17,122.01 0.8%
Nasdaq 4,526.48 4,569.62 1.0%
US 2yr yield 0.48% 0.52% 0.04%
US 5yr yield 1.64% 1.64% 0.00%
US 10yr yield 2.43% 2.36% -0.07%
Oil 93.48 93.77 0.3%
Gold 1,288.40 1,281.90 -0.5%
VIX 11.78 11.78 0.0%
Rahul Vaidyanath is a journalist with The Epoch Times in Ottawa. His areas of expertise include the economy, financial markets, China, and national defence and security. He has worked for the Bank of Canada, Canada Mortgage and Housing Corp., and investment banks in Toronto, New York, and Los Angeles.