December 14, 2018

Markets Today: ECB ends QE on a dovish note

Mario Draghi’s fear of growing downside risks didn’t do too much damage to the Euro.

Today’s podcast

Overview: Play that funky (market) music

  • ECB makes little change to baseline forecasts
  • Continuing confidence with increased caution
  • Draghi wouldn’t be surprised, delighted even, for markets to keep financial conditions still very easy, supporting ECB growth aspirations; Euro little changed after a dip
  • May in Europe endeavouring to redo Brexit; no vote till after Christmas; pound steady-to-higher
  • US import prices fall, thanks to the dollar and oil neutralising tariffs; jobless claims back down scotching recent thoughts of a rocky labour market
  • China activity data today important for AUD; MYEFO Monday and unemployment Thursday to round out the year with the FOMC; AUD sitting comfortably around 0.07225/30

ECB holds the line on forecasts and current outlook: Euro little changed, after a dip

In what has been an orderly and quiet market overnight, the main event has been the outcome of the ECB meeting, its forecasts, guidance and takeaways from Draghi press conference,.  The market was primed and expecting a very dovish ECB that the ECB seemed to deliver in its statement but much less so at Draghi’s subsequent press conference.

Continued confidence with increasing caution was one key take away phrase that the ECB wanted to leave the market with at its last meeting for the year.  The ECB was not as convinced about some of the external risks afflicting European economies as markets might have anticipated.  The ECB said in its opening statement overnight that, “the risks surrounding the euro area growth outlook can still be assessed as broadly balanced.” It then added, “However, the balance of risk is moving to the downside”, citing the often spoken of “persistent uncertainties relating to geopolitical factors, the threat of protectionism, vulnerabilities in emerging markets and financial market volatility.” There was an injection of a less worrisome outlook at Draghi’s press conference.

The Euro dipped on the formal statement, looking for a negative takeaway from the ECB. They confirmed that the QE program would be capped at the end of the year at €2.6tr and that rates “remain at present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium-term”.

As for thoughts of when the unwinding of QE might start, the messaging was not in essence dissimilar to the US experience that was a lag of two years between when rates started to rise and when the unwind started.  The ECB said that it will continue to reinvest principal payments from maturing securities from “for an extended time after the end of its net asset purchases” to “an extended period of time past the date when we start raising the key ECB interest rates and (as was the case before) “for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.”

At his presser addressing the external risks that the markets have been besotted with of late, Draghi remarked that, “actually the trade situation is probably better than two months ago” (perhaps a nod to the 90-day tariff freeze and improving mood music out of the White House, for now anyway) while the situation in some emerging markets is less dangerous, a reference to the stabilisation seen in areas such as Turkey, Argentina, Venezuela and Brazil, especially now that the market had scaled the extent of US rate rises for 2019, the Fed much more discretionary rather than gradual rises on “autopilot”.

Also in the Q&A, Draghi was asked why markets are more pessimistic than the ECB. In what was an interesting reply Draghi acknowledged there was a little less conviction in the latest ECB staff forecasts, but he observed that markets are reading the hard data and then easing financial conditions. This is said shows markets understand well the ECB’s reaction function, but also that the ECB never gets to the downside risk outcome as markets are doing the work for it.

One Bloomberg reported wrote that “this echoes former BoE Governor Mervyn King’s Maradona theory of interest rates that central bankers can sway market expectations without changing policy. In the 1986 World Cup, the Argentinean soccer star scored against England by running straight at the goal from midfield — beating five players who expected him to turn left or right on the way”.  It was a nice way for the ECB President to play the markets to get the very accommodative financial conditions to support achievement of their growth forecasts.

There was no material change to the ECB’s growth and inflation forecasts.  GDP for 2018 is down a tenth from September’s 2% to 1.9%, 2019 also a tenth lower at 1.7%, while 2020 is unchanged at 1.7% and a new 2021 forecast comes in at 1.8%.  Inflation for this year was increased a tenth to 1.8% and lowered a tenth next year to 1.6%.

Draghi remains upbeat on the domestic growth side.  On wages, he noted “the strength of the labour market,    ongoing employment gains …. supporting private consumption. He called out the over 4% rise in German wages. He also said that business investment is benefitting from domestic demand, favourable financing conditions and improving balance sheets, while residential investment remains robust.” Despite all the global trade angst, the expansion in global activity, “is still expected to continue, supporting euro area exports, although at a slower place.”

There has been little movement in major currencies overnight.  The biggest mover has been Sterling that has drifted higher (Cable up another 0.34% since 5pm AEDT yesterday), the DXY little changed as has been the AUD ahead of key China activity data today, trading at around 0.7225/30 this morning as we go to press.

Other economics: US data points to still low inflation and strong labour market

US import prices in November were less than expectations, down 1.6%, led by collapsing oil prices, but also the continued effects of the strong dollar, ex-petroleum prices also down, by 0.3%, neutralising the impact of tariffs on US downstream inflation.  Jobless claims were back down to just 206K in the week of December 8, down from 233K and while we can over-read week to week movements, it suggests the labour market still looks solid.  The USD was a little higher on this news.

Commodities, bonds, and equities

Oil has again stood out, now increasing on the day, WTI up to $52.59, up $1.44 on the day, a rise of just under 3%, a similar story for Brent. Prices were supported as news filtered through that the Saudis will cut shipments to US refiners soon to cap any upside to US inventories.  Base metals were little changed, as was gold, while in the bulks space, both Dalian iron ore and Chinese steel rebar futures were up.  Coal prices were also higher.

As for bonds, German bunds were little changed, Italian bonds rallied as the Italian PM signalled a deficit plan of just over 2% of GDP, while 10 year US Treasuries were little changed.  Two year Treasuries rallied ahead of what the FOMC might do to their dot plot forecasts next week.

Coming up

  • China releases not only the usual monthly Retail Sales, Industrial Production, and Fixed Assets Investment reports today (for November), but also now releasing monthly Property Investment and their Jobless Rate data.  All are important data points for the Aussie market, due at 13.00;
  • Before then, there is the Bank of Japan’s Tankan business survey, Q4 (10.50);
  • Tonight, there are the Germany & EC PMIs for Dec, while in the US, it’ll be the focus on the US consumer with the monthly Retail sales (headline held back by lower gas prices, bur core sales expected to be stronger;
  • It’s a big local week ahead as the last week for Australia with the unemployment figures and the Budget mid-year MYEFO update, revealing much better than budgeted balances this year.    There’s the FOMC next week too.

Market prices

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