Friday, September 13, 2019

Draghi makes good on promise; Eyes on US Retail Sales guiding the Fed's meeting next week

  • Dollar
  • Gold
  • Yen
  • Euro
  • Pound

Market recap: ECB announces monetary policy stance and asset purchase program plan

The European Central Bank yesterday announced its decision on its monetary policy – it cut rates to -0.5% and promised they would stay low for longer. It also announced bond purchases will be priced at 20bn euros per month from November onwards. Outgoing president Mario Draghi, hosting his last ECB meeting, also revealed purchases will continue until inflation is sufficiently close to, but below, 2%. The implication is that purchases will likely not stop until we see a rise in interest rates. While Draghi admitted some members of the ECB were opposed to restarting the bond-buying program, he reiterated that a clear majority supported the decision.

The euro fell to 1.09’s level after the announcement, and then rose sharply to 1.1080’s level after the hawkish statement from Draghi. Running 160 pips from the lowest to the highest, the euro’s volatility was higher than its G10 peers.

Wall Street edged upwards, thanks to positive headlines regarding China and the US’s trade war talks. Trump declared that while he prefers a comprehensive trade deal, he is not ruling out the possibility of a temporary one. The DJIA rose slightly by 0.17%, while the NASDAQ and S&P 500 showed better progress, edging higher by 0.30% and 0.29% respectively. The Dollar Index remained relatively flat.

Treasury yields climbed as investor sentiment responded to trade war positivity. Two-year yields rose 1% (or 5.3bps) to 1.72%, while 10-year yields reached a six-week high, rising 5.6bps. 30-year yields climbed 5.5bps to a five-week high of 2.26%. Gold retracted 0.2% while the dollar/yen rose, as demand for safe haven assets declined after yesterday’s developments.

Today’s analysis: Short-term trade war positivity doesn’t mean a long-term deal is in the pipeline

The stimulus package from the ECB is in line with our earlier expectations, which is less dovish than the market broadly expected. The main deviation was the amount of assets repurchasing, which is only 20bn euro per month and is the bottom line of the market’s expected range. Draghi’s view on the economic outlook is more upbeat - while he admitted the ECB has seen more protracted weakness in the economy, he is still expecting, “moderate but positive” growth in Q3 of 2019.

But many experts believe the ECB is not doing enough to boost the economy and the outlook for the Eurozone could be more negative than expected. In this case, we expect the ECB may need to once again cut the deposit rate by another 10bps at new president Christine Lagarde’s first meeting in December, and expand the bonds buying program for 2020.
The euro may have a short honeymoon period although the overall trend will still be downwards, especially when the Eurozone releases negative figures in the future.

Two pieces of key US economic data are due for release later today: the US August Retails Sales Advance and the University Of Michigan Sentiment Report for September. Investors are closely watching these two indicators, as they are likely to affect the upcoming Fed meeting on September 18th.

As manufacturing output is still being affected by the trade war, consumer consumption is currently the main prop for the US economy. Analysts are forecasting retail sales to correct to 0.2% in August from July’s figures. The increase is most likely thanks to a boost from online and mail order retails sales by Amazon’s Prime Day in July. Last week, average hourly earnings year-on-year rose to 3.2%, while the unemployment rate stayed flat at 3.7% for August. Last week’s data infers that while retail sales are forecast to return to normal, don’t expect sales for September to underperform market expectations.

The Fed is likely to include these two indicators (along with the CPI, PMI and unemployment data earlier this month) in its decision on monetary policy next week. With a lower than expected CPI of 1.7%, Service PMI decreasing to 50.7 and new Non-Farm Payrolls data adding only 130,000 new jobs, the Fed will probably implement lower rates. According to the CME Fedwatch, the probability for a rate cut for September is currently at 88.8%, which suggests the market is already pricing in a rate cut of at least 25bps.

Target Rate Probabilities for 18 Sep 2019 Fed Meeting

Earlier this week, China announced tariff exemptions on certain US goods, which prompted Donald Trump to delay US tariffs originally scheduled for October 1st until October 15th. Global stocks rallied on this news and Trump later remarked that although he is still seeking a long-term trade deal, he’ll still consider an interim solution. The two sides are slated to meet in early October.

The key issues surrounding the trade war are claims of unfair trading practices and intellectual property theft by the US. However little to no progress has been made on these issues and it is likely any optimism in the market will be short-lived.

With the next US presidential elections scheduled for November 2020, China is unlikely to give in to demands around issues that would require structural changes to its economy and its law. So while the market is bullish thanks to this week’s developments, we believe October’s talks will reveal the two superpowers are still miles apart from an agreement, and the market will price in a correction as a result.