The ECB is expected to announce fresh policy stimulus on September 12th as growth continues to slow throughout the euro area
The expected recovery in global economic growth in H2/H1:2020, due, inter alia, to more favorable financial conditions in H1:2019, comes with downside risks following the recent trade developments, and with Brexit remaining a key factor. Global manufacturing sectors are entering their 3rd recession since 2010. In the US, the services sector is weathering the storm, as the ISM-services index has clearly decoupled from its manufacturing counterpart, which fell below 50 for the first time since August 2016 (see graph below).
The US labor market report on Friday revealed that the pace of hiring, despite being boosted by temporary factors, is slowing, albeit to still healthy 156k on a 3-month average basis. The average work week rose and average hourly earnings were above consensus expectations on a monthly basis, bringing the annual change to 3.2%. So far, there is no material evidence that companies are reducing labor inputs. However, the additional tariffs imposed by the US and China in August/September could dampen trade further and weigh on confidence and market sentiment, adversely impacting investment and ultimately jobs.
There are heightened expectations that monetary policy will offset other headwinds. The People’s Bank of China (PBoC) on Friday cut the Reserve Requirement rate by 50 bps to 13%, releasing RMB900bn (0.9% of GDP) of liquidity into the Chinese banking system. Central bank meetings in other developed economies are expected to take place during September (see below). However, major central banks, excluding the Fed, are operating near or at their effective lower bound regarding interest rates. At the same time, fixed income term-premia have declined considerably, reducing the traditional large-scale asset purchases (LSAP) policy effect.
With economic growth hovering around 1% and inflation pressures muted as core CPI has been 1% on average in the past three years, the ECB is expected to announce, on 12 September, a policy package that will likely include a 10-20bp cut in the deposit facility rate (currently: -0.40%), most likely with a tiered system for reserves as part of banks’ profitability mitigating measures. Moreover, expanding forward guidance on interest rates (“at present or lower levels”) beyond mid-2020 or linked rates on QE (“well past the horizon of net asset purchases”) is highly likely, if net asset purchases are enacted. On the other side of the Atlantic, the Fed will meet on 18 September. It is expected to lower interest rates for a second consecutive time since July. As Chair Powell noted at Jackson Hole, the US outlook is positive partly because “shifts in the anticipated path of the policy have eased financial conditions”. Indeed, financial markets price in a 98% likelihood of a 25 bp reduction in the range of 1.75% - 2% and a 2% likelihood of a 50 bp cut.
Global equity markets rebounded modestly as trade headlines and a series of economic data came out stronger-than-expected. Indeed, the Citigroup’s US Economic Surprise index rose above zero for the first time since February (see Graph 1, page 3), pushing up the S&P500 by 1.8% on a weekly basis (+19% YtD). In a similar vein, modest risk-on, as well as profit taking ahead of central bank meetings, caused benchmark Government bond yields to rise by c. 5-10 bps --the largest weekly move in 9 weeks -- albeit from very depressed levels.