Central banks are delivering on their easing promises, with the ECB having announced open-ended QE. But, monetary policy is not the only game in town.
After delivering open-ended QE at the ECB’s September meeting, Mario Draghi’s firm message was that it is now the turn of fiscal policymakers to deliver the next dose of stimulus. And, indeed, while the Fed and PBoC have some scope to cut rates, albeit being reluctant to take meaningful steps, the ECB and BoJ simply do not have much room left for further rate reductions.
‘Reluctant cutter’ used to be a popular nickname for the Reserve Bank of Australia, when it was easing monetary policy at a snail’s pace in 2015 and 2016. We expect this moniker to gain popularity again, but this time to characterize the Federal Reserve Bank in its current easing cycle. Yes, the first cut was announced in July and there most likely will be another cut in September, but recent Fed comments suggest that the policymaker will administer its doses of easing with continued reluctance.
We expect the Fed to cut rates by another 75 bps, including 25 bps in September. Some further easing should probably be priced in, as risks to that central view are to the downside. Currently, 50 bps in Fed cuts are priced in for the September to December period, and an additional 34 bps for end 2020. For the September meeting we do not expect the Fed to ‘out-ease’ market expectations, or signal such intentions via its Summary of Economic Projections. Hence we see some risk of disappointment in front-end rates around this meeting, but beyond the next meeting we think that risks are tilted towards more easing than is currently being priced in.
It was no surprise to see ECB President Draghi live up to his reputation at the September ECB meeting by laying out a broad monetary stimulus package that ensures his presidency ends with a bang and not a whimper. Besides a 10 bps cut in the deposit facility rate to -0.50%, the ECB strengthened its forward guidance on policy rates by dropping the previous “mid-2020” calendar guidance and enhancing the state-based link to inflation. It now expects to keep rates at “present or lower levels” until it sees the inflation outlook robustly converge to the target, to the extent that such convergence is reflected consistently in core inflation dynamics.
The ECB also introduced a two-tier system for reserve remuneration and sweetened the terms on the upcoming TLTRO 3 operations. However, it was the “open-ended” nature of the announced restart of net asset purchases that led to a strong risk-on rally in Eurozone bond markets. Net purchases are expected to continue until “shortly before” the ECB starts raising rates which, in turn, is state-dependent on inflation dynamics: markets currently do not envisage rate hikes happening before 2022. This would imply cumulative net purchases of more than EUR 500bn.
As we predicted in our previous Central Bank Watcher, from July, the PBoC has used the reform of its interest rate framework to lower borrowing costs for the real economy: the loan prime rate (LPR) – from which new loans are priced – is now explicitly linked to medium-term lending facility (MLF) rates. The latter are much lower than the benchmark lending rates with which most existing loans have been priced.
Looking ahead, with growth data remaining unconvincing, with lingering downside risks related to the US-China trade dispute, and with PPI inflation tending to lead the closely watched credit impulse metric, we are fairly convinced that additional monetary stimulus will be forthcoming.
The BoJ is expected to maintain the status quo at its next meeting, on 19 September. This applies to all available policy tools, including policy rates, yield targets and asset purchases of ETFs and government bonds. While the ECB has moved towards a new round of monetary easing, with the Fed expected to follow, the trade-weighted yen is holding up very well. We believe this will allow Japanese policymakers to keep their additional easing options in reserve while sticking to their strategy of extended forward guidance, with perhaps a small rate cut somewhere during the next year.
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