At the beginning of this year, core central banks seemed set on a course of slow monetary policy “normalization”. But, with global growth increasingly under threat, accommodative policy seems to be back in the ascendant.
1. Markets increasingly expect a Fed rate cut. Mr. Powell and his colleagues are sounding increasingly accommodative.
The U.S. Federal Reserve had been much further towards monetary policy normalization, having previously hiked rates and started to run down its balance sheet. But a series of regional Fed Presidents and Chairman Powell have been stepping up the accommodative-policy rhetoric (page 2). In addition, market-based probabilities for an interest rate cut at the July FOMC have now gone above 70%. Of course, markets can be wrong, but the pressure does appear to be one way here. There may also be intermediate steps that the Fed can take to indicate policy loosening, for example an earlier-than-expected end to its balance sheet reduction plan. Meanwhile, data such as manufacturing PMI suggest that U.S. factories are responding to the slowdown in global growth; the spread between orders and inventories suggests that the current weakness also has not yet fully run its course.
2. The ECB has now pledged to keep rates at current levels for longer, but its policy approach will struggle to shore up growth.
The ECB had lagged far behind on the path to normalization; now it is wondering how to become more accommodative again. At this Thursday’s governing council meeting, it changed its forward guidance, with President Draghi pledging that interest rates would remain at the current level “at least through the first half of 2020” rather than just until the end of 2019, as stated previously (page 4). The ECB also confirmed that it will commence its TRTLO III program in September, which should provide a degree of support to the economy. But markets seem to have been expecting more dovish news, so the EUR strengthened immediately after the announcement – and European equities fell. Quite apart from the ECB’s own policy dilemmas, Europe’s political problems still seem likely to resist any quick solution, potentially undermining European risky assets.
3. Low inflation may encourage renewed policy loosening, but there are risks – not least to market behaviour in response.
With inflation levels still low (particularly in Europe), central banks may feel that they have some room for policy loosening. But there are still some dangers around it, not least in encouraging a drug-like dependence by the markets on continued hints of policy easing. This is all rather too reminiscent of during the nadir of the global financial crisis. Continued market volatility seems certain as a solution to current trade tensions takes time to emerge: we therefore stick to our call to take profits and recalibrate portfolios.
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