Contrasting the ECB with the Fed

Whether its year end book closing/profit taking and/or renewed doubts about the shape of recovery, asset markets have turned south recently.  Investor mood appears to be souring as risk aversion creeps back into the market psyche.  A string of disappointing US data releases over the last week including core retail sales, Empire manufacturing, industrial production, and housing starts, contributed to the reduced appetite for risk, resulting in a soft finish to the week for equity markets and a firmer USD.

Things are likely to take a turn for the better this week, however. Data will shed a little more light on the pace and magnitude of economic recovery and could result in some improvement in appetite for risk trades.  Despite an expected downward revision to US Q3 GDP, forward looking data on home sales, durable goods orders and personal income and spending as well as consumer confidence are likely to reveal increases.  In the Eurozone, data economic releases will paint a similar picture, including an expected increase in the closely watched barometer of business confidence, the German IFO survey. 

At the least economic data will remove some, but by no means all doubts about a relapse in the recovery process.  There is no doubting the veracity of the recovery in equity and commodity prices, despite doubts about its sustainability. Central banks may not react uniformly to this and the policy impact could vary significantly.  Already it appears that the ECB is moving more quickly towards an exit strategy compared to the Fed.  Although ECB President Trichet highlighted that the crisis is far from over at the end of last week, the Bank announced tougher standards for asset backed securities used as collateral, indicating that the need to provide emergency support to banks is much lower than it was. 

Clearly the ECB wants to avoid letting the market become over dependent on the central bank and will look to implement measures to this aim.  In contrast, the Fed is showing little sign of beginning this process and at least one member of the FOMC, namely St. Louis Fed President Bullard, was quoted over the weekend advocating that the Fed keep its MBS buying programme beyond its scheduled close in March. Evidence of the contrasting stance is also reflected in the fact that the Fed’s balance sheet is expanding once again whilst the ECB’s is contracting.  As a result of firmer data and comments by Bullard the USD is set to go into the week under renewed pressure, albeit within well defined ranges.


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