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Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)
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Recent market developments by Jorge Sicilia, Chief Economist BBVA Group (May 2014)

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Financial markets …

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

Published in: Economy & Finance, Business
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  • 1. Recent market developments. Jorge Sicilia, Chief Economist BBVA Foreign Exchange Contact Group Frankfurt, 6 May 2014
  • 2. 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
  • 3. 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 markets Source: 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)
  • 4. 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 yields monthly and YTD change, bps Source: Bloomberg and BBVA Research QE talks lend support to periphery bonds, mostly in the mid and long-end of the curves. SPAIN ITALY PORTUGAL
  • 5. 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 peers Source: 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
  • 6. 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
  • 7. 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
  • 8. Foreign Exchange Contact Group 6 May 2014 Page 8 World GDP Growth (% QoQ) based on BBVA-GAIN Source: 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 3Months ago Current 3Months ago Current Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Actual Estimates
  • 9. 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
  • 10. 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
  • 11. 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
  • 12. 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 Research Current 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 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 Series9 Series3 Series4 MICA-BBVA GDP observedCI 20% CI 40% CI 60%
  • 13. Foreign Exchange Contact Group 6 May 2014 Page 13 Positive external environment, but with doubts on the 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
  • 14. 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
  • 15. Foreign Exchange Contact Group 6 May 2014 Page 15 Inflation in the eurozone: baseline scenario Source: 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
  • 16. Foreign Exchange Contact Group 6 May 2014 Page 16 Measuring trend inflation through alternative measures Eurozone: 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%.
  • 17. Foreign Exchange Contact Group 6 May 2014 Page 17 Measuring trend inflation through alternative measures Eurozone: 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
  • 18. 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
  • 19. 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
  • 20. 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 1Yinfl. Swap 2Yinfl. Swap 3Y infl. Swap 1Y1Yfwd infl. Swap 2Y2Y fwd. infl. Swap 5Y5Y fwd. infl. Swap 5Y5Y fwd. Breakeven Impact on Flash HCPI Change 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
  • 21. 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
  • 22. 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/
  • 23. Foreign Exchange Contact Group 6 May 2014 Page 23 Fragmentation: implications for monetary policy. Conventional policy is less effective as the monetary-policy transmission is curtailed. Conventional policy is less effective as 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
  • 24. ECB. FXCP, My 2014 Page 24 Fragmentation calls for the strengthening of FG Interest rates under different policy rules Source: 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 Taylorrule 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
  • 25. 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
  • 26. Foreign Exchange Contact Group 6 May 2014 Page 26 QE: main channels by which QE may alter real rates Signalling channelSignalling channelSignalling channelSignalling channel Targeting channelTargeting channelTargeting channelTargeting channel Liquidity channelLiquidity channelLiquidity channelLiquidity channel Credit channelCredit channelCredit channelCredit channel Inflation channelInflation channelInflation channelInflation channel Conclusions from recentConclusions from recentConclusions from recentConclusions from recent experiencesexperiencesexperiencesexperiences QE announcements “postpone” date of first rate hike by around 4 to 6 months. InInInIn 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 Treasuryreduction in 10Y Treasuryreduction in 10Y Treasuryreduction 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 caveatsMain caveatsMain caveatsMain caveats in the EZin the EZin the EZin the EZ • Can it help reduceCan it help reduceCan it help reduceCan it help reduce fragmentation?fragmentation?fragmentation?fragmentation? • HowHowHowHow relevantrelevantrelevantrelevant isisisis moralmoralmoralmoral hazardhazardhazardhazard???? • Enough support?
  • 27. Foreign Exchange Contact Group 6 May 2014 Page 27 QE: heterogeneous impact on yields (from steady state). 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 channels Source: BBVA Research
  • 28. 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 also depend on how much of a surprise is the ECB announcement. Furhter impact on yields would also depend on how much of a surprise is the ECB announcement. Impact would be significant on peripheral bonds (reduction of around - 60/200 bps), less so on the Bund. Impact would be significant on peripheral bonds (reduction of around - 60/200 bps), less so on the Bund. For any particular bond, the targeting channel grows in importance the more is purchased by the ECB (relative to its total amount outstanding). For any particular bond, the targeting channel 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/
  • 29. 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-USD 1 Relation between Fed and ECB central bank assets, ratio Fed/ECB Source: 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-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Relative monetary policy stance EUR-USD (rhs) 0 100 200 300 400 500 600 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 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 sheet Index Jan 2007=100 Source: Bloomberg and BBVA Research * See Annex 3 for more details
  • 30. 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
  • 31. 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
  • 32. 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 Normalization Balance 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 yields Source: 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-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 10YT (lhs) 12-month ahead fed funds
  • 33. 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 markets Source 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-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 EUR 1y1y fwd OIS USD 1y1y fwd OIS ECB FG Rate cut Jan ECB meeting Mar. ECB meeting Mar. FOMC meeting Challenges ahead: will the EUR-rate decoupling persist?
  • 34. 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?
  • 35. Recent market developments. Jorge Sicilia, Chief Economist BBVA Foreign Exchange Contact Group Frankfurt, 6 May 2014
  • 36. 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
  • 37. 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
  • 38. 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
  • 39. 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*)
  • 40. 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*)

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