Euro area growth worries continue, amplified by weaker-than-expected euro area PMIs, prompting the ECB to reassess its balance of growth risks to the downside
Investors have remained optimistic since late-December, mainly due to: i) the Fed’s switch to using more dovish language than anticipated, while it is expected to remain on hold on January 29-30. Investors (who do not expect any hike this year) will focus on Chairman Powell’s comments; and ii) increased optimism for an agreement between the US and China on trade.
Regarding trade, expectations for an eventual resolution are high, while investors await top-level talks in Washington later on January 30-31 (Vice Premier Liu He will meet with US Trade Representative Lighthizer).
These factors have lifted risk sentiment, supporting equities and credit, with the MSCI ACWI up circa +6% ytd. Most major US banks began the earnings season on a positive note (Banks: +13.2% ytd), reacting calmly to the fact that fixed income, currency and commodity trading revenues were severely curtailed by a challenging market environment in Q4:18. Credit spreads have declined across the board (-9 bps to -24 bps), with the high yield spectrum over-performing in both the US and the EUR (circa +1%).
However, the slowdown of the global economy and the subsequent negative revision of 2019 corporate profitability continues.
The IMF revised down its global growth estimates to 3.5% in 2019 from 3.7% in 2018, due to slower growth in the euro area (-0.3 pps to 1.6% in 2019) and emerging markets (-0.2 pps to 4.5% in 2019). The revision reflects mostly a deeper contraction in Turkey, as well as carry over effects from softer German and Italian growth in H2:18. Moreover, a weaker near-term outlook for oil prices, which are expected to average just below $60/barrel in 2019 from $68 in 2018 (last WEO’s estimate for 2019 prices: $69), affects major producers negatively (S. Arabia, Russia).
Note that core government bond yields declined across the board, after the IMF announced its downwardly revised global growth projections. 10Yr German Bund yields declined below 20 bps on Friday 25 January, due to euro area growth worries and a slightly dovish ECB, with Mr. Draghi noting that the slowdown may be more prolonged than expected.
Note that the ECB kept policy rates unchanged (MRO: 0.0%, DFR:-0.4%), reiterating it expects them to remain at these levels “at least through the summer”, while QE reinvestment will continue for an extended period of time after the first rate increase. Importantly, the ECB now assesses the balance of risk surrounding the economic outlook to have moved to the downside, partly triggered by the consistent underperformance of incoming data. Indeed, the composite PMI declined by 0.4 pts mom at 50.7 in January, the lowest since July 2013, indicating just +0.1%-0.2% growth in Q1:19 (see Economics).