Thursday, September 12, 2019

Positive Trade War developments drive Wall St; Will the farewell ECB meeting of Draghi send a firework or a bomb to Euro?

  • China
  • Dollar
  • Gold
  • Euro
  • Pound

Market recap: Markets surge as the US and China grant concessions on trade ahead of October talks

The US markets ended yesterday in the green, as China and the US announced concessions on some tariffs ahead of their meeting in early October. China earlier announced it will exempt certain US goods, such as lubricating oil, and US President Trump responded by confirming tariff hikes on $250bn-worth of Chinese goods, originally scheduled for October 1st, would be delayed until October 15th.

The tariff headlines boosted the S&P500, which ended 0.72% higher, while the DJIA rose 0.85%. The Nasdaq also spiked 1.06% to 8170, in part because of the positive sentiment surrounding the trade war, but also in part thanks to Apple’s (AAPL) continued rise after it launched the iPhone 11, plus its new streaming service AppleTV+.

The mellowing trade war tensions have led to positive investor sentiment, while US Senior White House advisor Peter Navarro also advised investors and businesses to be patient with regards to the dispute. Investors retracted from safe haven assets as a result, leaving gold declining 0.26% while the dollar/yen increased 0.22%. The Dollar Index remained mostly flat.

Meanwhile, US treasury yields continued their climb. Two-year yields increased 1.6bps to 1.69%, 10-year yields lept to 1.75% or 1.3bps, and 30-year yields rose by 2bps to 2.23%.

Today’s analysis: Will Draghi’s final meeting see more rate cuts?

All eyes are on today’s European Central Bank meeting – and not just because this is the grand finale for current President Mario Draghi before he hands over the reins to new President Christine Largarde. Draghi has hinted previously that the ECB is preparing a new dose of stimulus for September’s meeting, including further reductions to its policy rate and the restarting of quantitative easing (QE).

The ECB will announce its decision at 3.45pm local time (GMT 11:45am), which will be followed by a news conference with Draghi at 4.30pm local time.

The euro has fallen 1.18% since the last ECB meeting on July 25th, as the markets priced in the rate cut and QE, especially after Draghi hinted the ECB would use QE through its asset purchase program to stimulate growth in the Eurozone. In line with Bloomberg’s sentiment, market consensus believes there’s a 62% chance the ECB will cut the deposit rate by 10bps to -0.5% (the current deposit rate is 0.4%) and a 38% chance the rate will be cut by 20bps to -0.6%. We’ve noticed a shift in opinion regarding rate cuts leaning towards a more dovish stance, as a growing number of analysts expects rates to be cut by 20bps instead of 10bps, on top of more quantitative easing.

In terms of asset repurchasing, most experts believe the ECB will announce a fresh bond purchasing program, with the amount projected to be between 20bn-40bn euro per month. The majority of analysts also believe the ECB will announce a small tiering rate system and a repricing of targeted longer-term refinancing operations (TLTROs). For example, the current interest rate and lending rate would remain unchanged until late 2020.

Euro-zone Deposit Rate consensus change between July and September's ECB Policy Meeting

According to our estimation, the ECB may cut the deposit rate by 10bps (-0.5%), introduce a restart of QE with 20bn euro per month, and add a small tiering system to relax current TLTROs. The final outcome may disappoint the market as it might not be as dovish as expected.

The economic growth of the Eurozone is shrinking, as Europe has suffered considerably from the trade war. The inflation rate was below the 2% target, with Q2’s GDP at 1.1% year-on-year. It means the ECB needs to dramatically change and loosen its monetary policy to boost the economy, although recent figures suggest it’s too soon to launch a huge package to stimulate the economy quickly.

Germany, the Eurozone and France’s composite PMI for August have beaten expectations at 54.8, 51.9 and 52.9 respectively, while Eurozone retail sales for July also rose above expectations year on year to 2.2%.

As Draghi is set to step down on October 31st, it’s unlikely he will try to boost the economy with clear dovish guidance, which would strongly influence future ECB policies.

The ECB is tipped to focus on cutting deposit rates and a smaller amount on quantitative easing than expected, and the euro may rise if the policy and Draghi’s comments are less dovish than predicted.

Different scenarios of ECB 12th Sep policy decision