This week marks the start of central banks in the developed world withdrawing monetary accommodation. Financial markets need to be prepared in advance, so all eyes are on the ECB meeting this week.
The two central banks due to release their monetary policies this week, the European Central Bank (ECB) and the Bank of Canada, will be the ones to start suggesting that it is time to discuss the removal of monetary stimulus. As the pandemic eases in the developed world due to successful vaccination campaigns, the economies are recovering and growth is resuming.
Out of the two decisions due this week, the ECB’s decision is more important for a number of reasons. Firstly, Euro area economic output is one of the largest in the world. Secondly, the ECB’s decision to taper may hint at the Fed’s decision to taper, too. Market participants are well aware of the fact that the Fed’s decision is due next week, and rumours persist that the Fed is in the early stages of a campaign to get markets ready for tapering.
Fed Dominating the US Treasury Market
2021 brought a spectacular development in the Fed’s strategy. The ongoing easing of monetary policy led to the Fed becoming the most important players in the US Treasury market. It is a bigger player than foreigners, as the $120 billion bond-buying programme continues.
But the Fed is not the sole central bank with such an influence. The ECB has similar “concentration” rates. For example, the Bank of Italy is the sole new owner of all Italian government debt issued in 2021.
It means that as tricky it is for the Fed to signal to taper, it is not alone. The ECB faces similar challenges, and this is why the next seven days in financial markets have the potential to be the most volatile in the second quarter.
A possible timeline for the Fed to start tapering looks like this. Firstly, the Fed discusses taper at its June/July meeting. Secondly, it announces the tapering at its September/November meeting. Finally, it begins to taper by next December/January.
The communication process is key here to avoid a taper tantrum. How will the markets take the tapering talks? We will have an idea this week, as the ECB leads the way.