September ECB Meeting
Backdrop
Today’s ECB meeting was particularly significant for three reasons. First, it followed a July meeting where the central bank took no action but set the stage for a resumption of easing: this meeting was due to bring to investors the confirmation of this renewed extension of the ECB’s accommodation programme. Second, it precedes the Fed meeting next week, which should see another rate cut: the extent of the ECB’s dovishness is an indication of the potential message of the Fed. Third, the Eurozone just entered its 20th month of economic slowdown and slower-than-expected inflation, with industrial production contracting by 2% in a year: the ECB’s intervention is now essential.
Mario Draghi’s final meeting as the ECB President was his last chance to mark his mandate as a central banker. Market expectations were on the dovish side, pricing in a 10 bps cut to the deposit facility rate and a restart of the asset purchase programme, with some members of the council showing a limited alignment. The December 2015 situation was the key risk of this meeting, but this time the ECB did not fail markets: not only did it cut rates as expected, it also announced the relaunch of an asset purchase programme of EUR 20bn per month for “as long as necessary”, an adaptation and an extension of the maturity for LTROs, and a two-tier system for reserve remuneration exempting part of banks’ holdings from negative rates.
These announcements follow a change in the ECB’s economic projections, which were cut given the further deterioration in economic conditions in Europe. GDP growth for 2019 is now expected to reach no more than 1.1% (vs. 1.2% previously). The 2020 inflation forecast is 1% (vs. 1.4% previously) as growth slows down and commodity prices remain muted. On the back of these deteriorating conditions, the ECB decided to act with strength. The most important message in our view was the clear forward guidance given by the ECB, which will help the economy “as long as necessary”: a strong commitment from the central bank that should further fuel the market’s recent upside.
Market Impact
The initial reaction was a consistent “beta party”, together with a decline in the value of the euro. The German 10-year rate declined by 6 bps pre-press conference, while the Eurostoxx gained about 70 bps. The euro vs. US dollar declined by half a figure. Overall, the ECB gave further evidence of its long-lasting support to both the markets and the economy. Past the press conference, rates and the euro reversed their initial moves as equities partly held their ground.
Asset Allocation Consequences
We have been communicating for some time on the U-turn from central banks around the world. This ECB meeting is just one more symptom of that and across the G10 a further 250 bps of rate cuts are expected over the next year. This element of the macro picture comes in a timely alignment with the other dimensions that drive our tactical investment decisions: sentiment and valuation.
The macro deceleration that started in February 2018 has not yet ended, but, with the exception of the Eurozone, there are no early signs of an imminent recession. This deceleration has helped central banks to become one of the main drivers of markets, as inflation has been nowhere to be seen. The macro deceleration has kept volatility low, pushed some equity market indices up and longer-term rates down. This dovishness helped turn market sentiment in January this year and should continue to do so over the medium term: today the ECB gave a clear sign of being part of this picture.
From a valuation perspective, this bold move has made all hedging assets expensive, while growth-related assets (equities and credit) now look more attractive despite the recent rally. As long as our Growth Nowcasters are not giving signs of an imminent recession in the global economy, what we see now is an alignment of stars: growth remains decent, inflation risk is very low, sentiment is more positive and valuations remain neutral to attractive for growth assets overall. We therefore prefer stocks and credit to government bonds.
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