Whatever it takes… all over again!

Published on 18-06-2019 13:22:09

Author: Alastair George

Alastair George is Edison’s chief investment strategist. He has extensive experience, having worked in global markets as a fund manager and risk arbitrageur since the 1990s. With an academic background in engineering and data science, he is well versed in the data-focused analysis of financial and political events.

With eurozone core inflation falling to 0.8% year-on-year in May and 5-year forward inflation expectations falling to under 1.2% in recent weeks, indications from the ECB that all options are on the table to return inflation to below but close to 2% can hardly be a surprise. Adding to a steady flow of sourced and unsourced press commentary by ECB policymakers since this weekend, outgoing ECB President Draghi has effectively promised to do whatever it takes – all over again – to bring eurozone inflation back to target. This is unambiguously positive for eurozone bonds, negative for the euro and in combination with an expected easing of monetary policy in the US, supportive of gold.

Exhibit 1:Gold benefiting from likelihood of simultaneous easing of US & Eurozone monetary policy
Source: Refinitiv at 18 June 2019

However, despite the comforting rebound in equity markets since central banks largely confirmed earlier market expectations of easier policy later in 2019 we would not underestimate the challenges ahead for corporate sector profits growth. There has been a very marked slowdown in PMI survey data on a global basis in recent months. We believe the lurch towards protectionism in evidence from the current US administration is largely to blame for the most recent ebbing of economic momentum.

Following US Commerce Secretary Wilbur Ross’ comments earlier this week, which suggested the best that could be expected of the upcoming G20 meeting would merely be an agreement to restart talks, the US/China trade war remains likely to continue for the foreseeable future. In this regard US President Trump’s tweets, today criticising Mario Draghi’s comments and the corresponding fall in the euro, highlight the risk of a race to the bottom in terms of ever-escalating tariffs and offsetting monetary policy.

In this scenario, central banks effectively engage in competitive interest rate cuts to offset the impact of tariffs on the real economy. This would not in our view ultimately be a positive situation for global equities and adds weight to our cautious stance on sectors exposed both to cyclical factors and global supply chains. The very weak 47.7 reading for the flash eurozone manufacturing PMI during May follows a steady loss of momentum dating from early 2018; we believe that corporate profits forecasts for 2019 may come under renewed pressure in coming months if the slowdown continues.

Exhibit 2: Eurozone manufacturing PMI firmly in contractionary territory

Source: Refinitiv/Markit at 18 June 2o19

The sensitivity of markets to changes in ECB policy also highlights the open question of the imminent replacement for Mario Draghi as ECB President. The ECB may be governed by its Council but the President remains responsible for communicating policy moves to the market and is the most influential voice by far. In this regard, Draghi while he may have wished to have provided his successor with a blank canvas he may instead have felt compelled, given the deterioration in the data, to raise market expectations of further monetary easing now.

Despite US President Trump’s weighing-in on the ECB’s predictable policy response to slowing growth and inflation data, we expect the resulting decline in the euro to be at most modest as the US Fed’s deliberations this week will also in our view at least signal a cut in interest rates in July or perhaps even announce a cut to US rates on Wednesday. With central banks on both sides of the Atlantic in easing mode for the foreseeable future and global political tensions remaining elevated, government bonds and gold are likely to continue to find favour amongst investors, in our view.

Exhibit 3:10y Bund yields touch record lows as further ECB easing anticipated
Source: Refinitiv at 18 June 2019

Source: Refinitiv at 18 June 2019


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