Global central banks continued to ease monetary policy in response to a deteriorating global backdrop, according to BofA Merrill Lynch, Global Research report.
Both the ECB and China’s PBoC cut interest rates this week, while the Bank of England kicked off another round of its quantitative easing program. As we expected, the ECB lowered interest rates by 25bp and brought deposit rates down to zero. In the UK, the BoE announced it aims to add £50billion to its balance sheet over the next four months. Meanwhile in Asia, the Chinese central bank surprisingly cut interest rates less than one month after it last lowered borrowing costs.
Most importantly, policymakers’ continued focus on downside risks backs expectations of further policy support. The ECB sounded more concerned about area-wide demand conditions and, although ECB President Mario Draghi discouraged hopes of further non-standard measures such as new LTROs, we think the Governing Council will lower interest rates once again before the end of the quarter. Likewise in China, we look for follow-ups to this week’s rate cut.
Reserve requirement ratios will probably be lowered within the next few days, and we expect the PBoC to cut interest rates twice more before the end of the year.
Global confidence stumbled again, with the global PMI dropping to 49.6 in June from 50.1 in the previous month. In the US, nonfarm payrolls expanded by a below-consensus 80k in June, while the unemployment rate remained at 8.2%. This brings the 2Q average to 75k, well below the 226k per month seen during the first quarter. The unemployment outflow rate – a statistic tracked by Federal Reserve staff1 – remained close to historically low levels.
Besides further interest rate cuts in the euro area and China, we also expect the Federal Reserve to underwrite $500billion worth of QE this quarter. If we are right, systemic central banks will have largely fulfilled recent market expectations of significant policy rescue. But for risk assets to rally more consistently, investors need to see more than willing-and-able central banks, in our view. On top of expanding liquidity, a meaningful market rally needs: (i) an abating sovereign crisis in Europe; and (ii) improvement in the global data. Are these conditions likely to materialize?
We think the crisis in the euro area will remain an open sore. The outcome of last week’s summit indeed revealed steps in the right direction. But it was no game changer. As German officials have been keen to highlight, the principle of no mutualization of national liabilities without sovereignty transfers looks intact.
Moreover, the painstaking debate on what both shared banking supervision and ESM direct help to banks entail is only beginning. As Laurence Boone explains, the effectiveness of a banking union lies in the details.
The Eurogroup will meet next week, when we hope to learn more about the conditions underpinning the Spanish banking bailout. By the end of the month the Troika should unveil the magnitude of funding gaps in Greece. With policymakers still balking at prospects of another debt relief round (that is, official sector involvement), pressure on the new Greek government is likely to mount. We have seen this before: if the Troika pushes for significant adjustment over a short period of time the weakest link of Greek political stability will likely break. The well-known Greek dilemmas should resurface soon.
The looming fiscal fog All in all, therefore, market respite opportunities are likely to be few and far between. On the plus side, global monetary conditions should continue to ease.
Next week, whereas we now expect the BoJ to stay put, we look for the Brazilian central bank to cut interest rates by 50bp. Likewise, India’s RBI will probably reduce rates by the end of the month. However, as we illustrated last week, easier monetary policy can only cushion the blow from higher uncertainty in the US and Europe. Effective policy breakthroughs would thus have to come from compromises in the European Council or in US cross-party politics.
Investors have yet to zero in on the real impacts of rising economic uncertainty in the US. As Ethan Harris and Michael Hanson have argued, it is unlikely that the cliff is fully priced into the markets. The issue may only start to visibly influence the consensus once lumpy economic decisions – such as business investment and durable goods consumption – start being postponed in the run-up to the cliff.
In all likelihood – and much like last summer – US political dysfunction will share the spotlight with the European crisis over the next few months. And as last time, the joint act will likely undercut investor confidence.