Deutsche looks at the role of oil in central bank thinking:
The financial world is trying to work out what the implications are for the energy price shocks we are seeing and whether central banks should tighten policy as a result or keep policy loose to reflect possible demand destruction that it might eventually bring. Indeed yesterday ECB President Lagarde warned that the “key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium-term”.
However, this has not been how they traditionally respond to big energy moves. Today’s CoTD (with a hat tip to DB’s Francis Yared) shows that since the ECB came into being they’ve tended to consistently tighten into rising oil prices (green on the graph) and loosen when they notably fall (red). The exception was in March/June this year when they loosened further by increasing the pace of the PEPP. So it’s interesting that in a world where central banks and markets tend to focus on core inflation rather than headline, the ECB’s monetary policy has been very linked to the ebb and flow of oil prices over the last 20 plus years.
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Francis Yared updated DB’s yield forecasts a couple of weeks ago. He saw US 10yr at 1.80% by YE21 and 2.40% by H1 2022. For 10yr Bunds he saw -0.1%by YE21 and 0.25% by H122. He believes the decision to extend PEPP into March and June may have been a factor helping the extreme summer rally in global rates. As they have now started to reverse that, alongside more hawkish moves from other central banks, it perhaps helps explain why we are in a rising bond yield environment for now.
The first point to make is that it is no longer so clear-cut that the US is hurt by oil shocks. These days, shale oil drilling is so big that the supply side boost is considerable. That is even more so right now because the rig count rebound has been so muted so far and will accelerate as prices rise:
Second, US oil inflation has been much higher than European owing to previous currency moves and the role the US plays as global marginal price setter for oil via shale:
US core inflation is also much higher than European:
The Fed is going to taper. The ECB is not. DXY up.
Energy crisis over in due course.