European and US markets sank rather sharply yesterday, inhibited by mixed messaging from the European Central Bank about further stimulus, and the prospect that next weeks Fed meeting may not be as dovish as expected.
This uncertainty has elicited a similar response from markets in Asia where the Bank of Japan also has a similar decision to make next week about easing policy further.
Yesterday’s ECB meeting saw the governing council appear to commit to ease policy further when they next meet in September. It was also made fairly clear that any easing would probably come on multiple fronts, not only in terms of a reduction in the deposit rate, but also in terms of measures that would include some form of tiering in order to protect Eurozone banks who are struggling with the effects of short and long term negative rates, along with some new easing measures, on an as yet undefined set of assets.
The ECB also said it would look at adopting a much more symmetrical approach to its inflation targeting, allowing overshoots in the same way as the Federal Reserve and the Bank of England.
There was also change to its guidance with the language being changed to say that rates would stay at current levels “or lower” through mid-2020. This was expected; however, the ECB may have missed a trick here.
Over the past year or so they have been rather timid in this area when it comes to its forward guidance. When as ECB President, you admit that things are getting “worse and worse” why not go all in and say that rates are likely to stay lower until, and possibly beyond, 2020. Don’t then go and undermine your message by then saying, you don’t see too many reasons to feel gloomy.
Yesterday’s reticence may have more to do with an admission by the ECB President that there wasn’t unanimity on taking action today, and that would appear to imply that there may be significant resistance amongst some on the governing council to much lower negative rates, which also helps explain why the euro was unable to follow through on its move down to new lows at 1.1102.
It probably isn’t too difficult to see where the resistance to this may be centred, when the economy in Germany is “free fall” on the manufacturing side, and German banks are particularly susceptible to the low and negative rate environment. Yesterday’s IFO reading was the lowest in six years with recent comments from IFO chief Fuest saying that extra QE wasn’t the answer, to trade and supply chain shocks.
Furthermore, now that Bundesbank chief Jens Weidmann is out of the running for the ECB Presidency, he may find that any reason to be overly dovish may well have disappeared with the selection of Christine Lagarde to replace Mario Draghi, as ECB President.
Another reason for the ECB to delay showing its hand yesterday was probably more political, with a Trump tweet never too far away, along with next week’s US Federal Reserve rate meeting.
The reality is a 10bp point rate cut is neither here nor there in the wider scheme of things and would be a token gesture given it is already priced in. Furthermore, with the US Federal Reserve expected to cut rates next week, it probably doesn’t hurt too much to wait to see whether the Fed does the ECB’s job for it, by being slightly less dovish than expected.
While few people expect the Fed to cut by 50bp they might not be as dovish as some people expect in a few days from now, and given recent data could well find themselves split on not only the decision to cut rates by also on what comes next.
Recent commentary doesn’t suggest that a 25bp cut would be unanimous with possibly Esther George of the Kansas City Fed dissenting, while Eric Rosengren, Boston Fed President also suggesting that he was in favour of waiting as recently as last Friday, citing the US economy which he said was still “quite strong”
This week’s US data hasn’t done much to alter that calculus, after durable goods for June rose 1.2%, while weekly jobless claims fell sharply to 206k, a three-month low.
Today’s first iteration of US Q2 GDP number could well introduce further doubt into market expectations of what sort of messaging that we might get from the Federal Reserve next week.
While there is no expectation that we won’t get a weaker number than the 3.1% seen in Q1, there is a chance we could see an upside surprise.
Early estimates are for a number between 1% and 2%, with recent revisions suggesting something nearer to 2%. Any number above 2% would inevitably raises questions as to why it’s even necessary to consider a rate cut, but given weaknesses elsewhere in the global economy, it would still be a big surprise were the Fed not to go next week.
EURUSD – slipped as low as 1.1101 before rebounding back to the 1.1190 area. The bias remains for a move lower towards the 1.1000 area, while below 1.1280. We need to see a recovery back above 1.1280 to retarget the 1.1400 area.
GBPUSD – currently holding above the two-year low from last week at 1.2380. Needs to hold above here to argue for a move back to 1.2580, or risk a deeper move towards the 1.2100 area.
EURGBP – slipped as low as 0.8891 before rebounding, however we need to see a recovery through the 0.9000 area to argue for a move back to the 0.9050 area. Bias has marginally shifted towards the downside with a test of 0.8870 initially and then 0.8820.
USDJPY – continues to edge higher but needs to take out the 50-day MA which capped it earlier this month. For the rally to gain momentum we need to push back through the 108.80 area to retarget a move to the 109.20/30 area. Bias remains to the downside and the 106.00 area, while below the 109.20 area.
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