The ECB may explain future long-term liquidity provisions, while a dovish change in forward guidance, vis-à-vis interest rates, could be postponed until the April meeting
Equity markets were muted regarding weaker-than-expected US economic data on Friday (ISM manufacturing, December real consumption expenditure) due to: i) optimism -- fueled by a WSJ article -- surrounding an agreement to end the US-China trade conflict, likely around March 27th; and ii) a better-than-expected Chinese PMI outcome -- the highest level in three months – which was only marginally below the neutral threshold of 50, reflecting an improvement in domestic demand and indicating that the Chinese Authorities’ policy support measures are starting to bear fruit. The National People’s Congress (March 5th) will confirm the authorities’ efforts to stabilize 2019 growth including, inter alia, a higher fiscal deficit target and a VAT cut.
Overall, global equities were up by 0.3% wow (+11% ytd), with an overperformance in the bourses in both China (positive news regarding trade, MSCI inclusion of A-shares -- see Markets) and Italy (Banks rallied). On the other hand, large-cap, export-oriented UK equities (FTSE100) lost ground in the past week (-1%) and have underperformed their developed market peers by circa 500 bps ytd as the strength of the British Pound (touched its highest level since mid-2018 at GBP/USD 1.33) is a headwind for overseas earnings of UK companies and correlates negatively with FTSE100 price returns.
Government bond yields increased by circa 10 bps across core markets, as risk-off mode declined, while political factors fueled the yield-increase of specific markets. Indeed, 10-Year Gilt Yields rose by 15 bps to 1.30% in the past week, as the threat of a no-deal Brexit by March 29th subsided. We maintain a negative view on Government bonds due to the current low levels of yields (European), while we also expect a stabilization of economic data and a waning of recession premia. We now hold a more constructive tactical view vis-à-vis corporate bonds (see Asset Allocation). Spreads have narrowed significantly ytd, but remain 20-30 bps wider relative to their Q4:2018 lows. Moreover, trade risks are fading and the Fed has adopted a more dovish stance implying fewer (if any) interest rate hikes in 2019-2020, a supportive factor for corporate fundamentals.
Key market drivers this week are the US February employment report (Friday | consensus expects nonfarm payrolls at 185k, unemployment rate at 3.9% and wages at 3.3% yoy), as the US economy is projected to slow in Q1:2019. The Fed’s dovish shift was confirmed by the leadership trio of Powell, Clarida and Williams in the past week. The FOMC minutes from the January 29-30 meeting indicated that “almost all” policymakers favored a late 2019 end to the balance sheet (B/S) contraction, with Chairman Powell recently suggesting that the runoff could stop when the B/S reaches 16% – 17% of GDP (or $3.5tn - $3.7tn) from $4.0tn currently.
Equally importantly, the ECB is expected to revise down its 2019 euro area GDP forecast to 1.3%-1.4% from 1.7% in December, reflecting lower-than-expected qoq GDP in Q4:2018 (0.2% qoq) and a downbeat quarterly path during 2019. Lower oil prices and a weaker EUR nominal effective compared with three months ago is expected to have a small upward impact of 0.1-0.2 on real GDP growth forecasts, offsetting carry-over effects from a weaker 2019 and implying 2020 and 2021 real GDP growth rates of 1.5%-1.7%. One should not rule out hints regarding future liquidity injections (LTROs/TLTROs) and a (dovish) change in forward guidance on Thursday.