July ECB Meeting
Today’s ECB meeting has been the main market focus this week and for good reason: central banks are currently the main market drivers.
Market expectations were dovish ahead of the meeting, with some expecting a potential rate cut. The ECB left rates unchanged but paved the way for further easing with new paragraphs in the statement showing a strong determination to act. The ECB said it will examine options for potential asset buying and tiering options. The Governing Council sees interest rates remaining at present or lower levels, at least through the first half of 2020.
During the press conference, ECB President Mario Draghi reiterated that the organisation remains committed to doing whatever it takes. He added that inflationary pressures remain muted and that expectations had declined, justifying ample need for accommodation. He added that geopolitics and protectionism, as well as softening global growth, were also responsible for dampening sentiment.
Draghi also pointed out that no discussion around rate cuts took place today and that any cuts further down the line would come with mitigating measures.
The initial reaction was a quick and short-lived rally in EUR following the unchanged rates announcement. The dovish statement was however quick to catch up with the market with the EUR reaching new intraday lows of 1.11.
The Euro Stoxx rallied above 3,550 while European rates moved lower with the Bund yield falling to new all-time lows.
During the press conference, the moves consolidated before Draghi confirmed any rates cut would come with mitigating measures. However, initial moves were reversed following Draghi’s later comments regarding no rate cut discussion and mitigating measures.
Asset Allocation Consequences
We have been commenting for some time now on the central bank U-turn that has taken place globally since late last year. A few exceptions still exist but they remain a minority (e.g. Norges Bank). Our investments are based on three themes: macro, sentiment and valuation.
The macro deceleration we observed late last year seems to have stabilised for now. With no macro shock (recessions) on the horizon, sentiment dampened by geopolitical risk, and valuations painting a mixed picture, central banks have been one of the main market drivers despite some dispersion. This has kept volatility low, sending some equity market indices to all-time highs and driving bond yields lower, and some to record lows.
The dovish turn by the ECB was not surprising. The Eurozone remains one of the weak spots within the developed market world. This was first indicated by our proprietary Growth Nowcaster in the latter part of last year and continues to be the case this year.
With no inflationary pressure and growth around / below potential, central banks can focus on supporting further economic expansion by delivering pre-emptive easing via cuts and balance sheet expansion. Such action is likely to continue to be supportive for markets, as this will reduce recession risk while keeping volatility low. We remain long growth-oriented asset but with hedges and favour carry strategies in Credit and FX.
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