The week started with the news that the U.S. Senate passed the stimulus bill over the weekend. After marathon negotiations and debates, Senators gave the greenlight to even more stimulus for the American people This time, $1.9 billion will flood the market, despite the fact that the American economy is healing faster than expected.
Friday’s NFP report showed that the jobs market is turning a corner. Because the vaccines do work, the U.S. administration’s efforts start paying off. Currently, America’s vaccination pace reached 2.5 million people per day, putting the country as one of the favorites in the race to ending the pandemic.
Yet, everything above is already old news. What lies ahead is even more important – will the US Treasury yield continue to rise? More importantly, what will the European Central Bank (ECB)’s response be?
Challenges for the ECB
The ECB is facing a plethora of challenges at this week’s meeting. To start with, Europe lags in the vaccination race terribly. At the current pace, the U.S. will end inoculating all its adult population a year earlier than Europe will do. The lag poses an economic concern for the central bank that must diverge its policy from the one in the United States.
The biggest problem the ECB faces right now is the rising long-term yields in the United States. As the economy across the ocean recovers faster, yields are pricing it in. As such, financial conditions tighten in America, with spillover effects in other parts of the world.
Yet, Europe desperately needs easing conditions, as the fight against the pandemic is poised to last longer. Therefore, the ECB will likely act against the unwanted tightening from the US Treasury yields, by purchasing more bonds under its asset-buying program (i.e., PEPP).
In doing so, the ECB faces another problem – rising inflation. Inflation in the Euro-area increased at its fastest pace in more than a decade recently, and the pace seems to continue. After all, the main driver to higher inflation, the price of oil, continues to rise; the WTI crude oil price closed above $65 last Friday.
To sum up, the ECB is pressured on three fronts – the vaccination race, the unwanted tightening conditions triggered by the rise in the US Treasury yield, the rising inflation. Investors are eager to find out Lagarde’s response to this puzzle. What will the EUR do?