Global Economy & Markets, Weekly Roundup 23/07/19

23/07/2019 - Reports

Global Economy and Markets

US banks’ earnings announcements for Q2:2019 begin on a positive note, with investor attention now turning to the ECB
Key Takeaways

The European Central Bank, at its meeting on July 25th, is expected to lay the groundwork for fresh policy action. Forward guidance modifications with an easing bias appear likely. In that context, the Governing Council’s expectations for interest rates “to remain at their present levels through the first half of 2020” could be changed to “at their present or lower levels”. There is also a possibility of adding an explicit reference to the possibility of resuming net asset purchases.

Economic conditions could also be cited as a trigger for further monetary policy accommodation. Two conditions will be taken into account. On the one hand, the view which was reflected in the minutes of the June meeting that a deterioration of current economic conditions will need to take place for further action (“in case of adverse contingencies”). On the other hand, President Draghi’s view in his speech at the ECB Forum in Sintra, Portugal, in mid-June (“in the absence of improvement of the economic outlook”). In our view, the latter condition will prevail, resulting in a lower bar for further action.

Specific policy measures are not expected to be undertaken until the September meeting, when more economic data will be available and the quarterly ECB staff forecasts for GDP and inflation will be updated, allowing policy makers to calibrate the correct policy response. A measured cut to the Deposit Facility Rate (DFR), likely by 10 bps (currently: -0.40%) in September appears the most likely outcome. A possible move deeper in negative territory would also likely include some DFR tiering, in order to mitigate the negative effect on banks’ profitability.

At the same time, the restart of QE may be delayed until later in the year (December). Regarding the modalities of a potential new Asset Purchase Programme (APP), visibility is currently low, while ECB officials have noted that some of the self-imposed restrictions in the previous APP (i.e., the 33% issue and issuer limit regarding the share of Government bonds that the ECB can hold), could be removed to expand the available pool of assets. In any case, monthly net purchases of €30 bn for a period of 9 – 12 months (thus a total size of €270 bn - €360 bn or 2.3% - 3.1% of euro area GDP) appear feasible. Recall that the ECB accumulated circa €2.65 trillion in assets or 23% of euro area GDP during 2014-2018, while it will continue to reinvest maturing bonds for a significant period of time following the first rate increase.

In September, the ECB will also have to take into account the input of the July 31st Fed meeting, where a cut to the Federal Funds rate forms our baseline scenario. In the event, recent dovish commentary by Fed senior officials, Clarida and Williams (both voting members of the Federal Open Market Committee), briefly supported market expectations that the anticipated cut to the Federal Funds rate could be 50 bps.

Nevertheless, the Federal Reserve Bank of New York released a statement pushing back on the market interpretation of Williams’ remarks (see Quote on page 3) and, as a result, consensus now calls for a 25 bp cut in the range of 2.0% - 2.25% at the end of the month and four rate cuts are priced in, cumulatively, in the next 18 months. Note that markets price in a c. 25% likelihood of a 50 bp move this month.