Will the ECB live up to investor expectations?
When Mario Draghi speaks on Thursday, the market will be hanging on his every word. Eurozone bond markets have staged a powerful rally since the European Central Bank chief indicated last month that a fresh round of easing measures is on the way to combat stubbornly low inflation and a flagging economy.
Investors are betting heavily on interest-rate cuts — possibly as early as this week — and a revival of bond purchases, known as quantitative easing, later in the year. If a July rate cut fails to materialise, Mr Draghi’s forward guidance will be crucial: he is widely expected to add the words “or lower” to the ECB’s projection that rates will remain at their current level until next summer.
Anything less could disappoint markets, according to Marchel Alexandrovich, senior European economist at Jefferies. “People have been trading on the assumption of more QE before year-end and maybe jumping a few steps ahead,” he said.
Currency traders have also set a high bar for Mr Draghi, according to analysts at Nomura.
“We think the euro will trade weakly into the ECB meeting, but disappointment risk is relatively high and a knee-jerk rebound is possible in the short term,” they wrote.
Even so, investors seem convinced the ECB will roll out the big guns later in the year. According to a survey by Bank of America Merrill Lynch, more than 60 per cent of fund managers expect more bond buying by the end of the year. That belief is likely to continue weighing on bond yields.
“I don’t think Draghi will close the door to anything,” Mr Alexandrovich said. “Whatever happens at the July meeting, more easing is coming.” Tommy Stubbington
Will economic data keep ‘trolling’ the Fed
The US central bank has shifted in a decidedly more dovish direction over the past month, moving from signalling that interest rates are on hold to hinting heavily that the first rate cut in nearly a decade may be on the cards at its upcoming meeting. The problem is that the economic data has been challenging that view ever since the Fed’s shift.
Last month’s employment data thumped economists’ forecasts when reported at the start of July. The core inflation rate then accelerated and last week US retail sales data were unexpectedly buoyant, indicating that the engines of the economy are still going strong.
“Retail sales crushed it,” said Tom Porcelli, chief US economist at RBC Capital Markets. “In other words, the Fed is poised to cut rates even in the face of very sound economic fundamentals in place.”
Investors still believe the central bank will cut rates on July 31 — a conviction strengthened by chair Jay Powell’s dovish testimony to Congress earlier this month — but if data remain strong over the coming week, some doubts may begin to creep in. The biggest releases in the coming five days are Markit’s purchasing managers indices for services and manufacturing, home sales, durable goods orders and jobless claims. The week culminates in the first estimate for overall economic growth in the second quarter.
The pace of growth is expected to slow from the surprisingly rosy first quarter, but another batch of buoyant data might embolden the Fed’s hawks and force investors to reassess their view that several rate cuts are coming.
“By cutting rates now, [the Fed] risks having no firepower if the economy actually turns down and goes into recession,” said Chris Rupkey, chief financial economist at MUFG. “ ‘Save the rate cuts for a rainy day’, is what consumers are telling the Fed. ‘We don’t need them.’ The Fed says they listen; let’s see if that’s the case.” Robin Wigglesworth
Will the world economic outlook improve?
The International Monetary Fund is due to issue an update to its World Economic Outlook on Tuesday, providing clues about the state of the world economy following a downbeat assessment of global growth in April.
In its last release, the IMF highlighted the drag that trade tensions have had on growth, and said monetary policy remained somewhat restrictive, as it cut forecasts for 2019 and 2020. Since then, ructions between the US and China have remained unresolved, and new US trade war fronts have opened up with Mexico, India and the EU — but the Fed has shifted to signalling the start of a rate cutting cycle.
“Central banks are shifting toward monetary easing, as they aim to cushion a global slowdown sparked by trade tensions,” said analysts at BlackRock. “This policy pivot should help stretch the [economic growth] cycle.”
Three months ago, the IMF pinned hopes for a rebound on a “precarious” boost from emerging markets, expecting an end to crisis conditions in Argentina and Turkey and a stabilisation in China’s growth rate.
Argentina’s economy has indeed improved, while Turkey emerged from three quarters of contraction in May. China’s economy, however, grew at its slowest rate in nearly 30 years despite being buoyed by domestic consumption.
With a mixed bag of signals to digest, analysts are not expecting a major shift in the Fund’s July update. A consensus forecast of economists polled by Bloomberg points to global growth of 3.3 per cent in 2019 — right in line with the IMF’s previous estimate. Siddarth Shrikanth