The key central banks have a preference for injecting liquidity rather than further interest rate cuts. But is the cutting cycle over?
As they await a rebound in the business cycle, the key central banks maintain a preference for injecting liquidity via bond purchases (ECB and BoJ), T-bill purchases and repo operations (Federal Reserve) and RRR cuts (PBoC) over deploying further interest rate cuts. However, we see a chance that the interest rate easing cycle may not be fully over yet, especially in the US and China.
In the Eurozone and Japan increased concerns over the negative side effects of a prolonged period of negative policy rates seem to have raised the bar for further interest rate reductions. At the same time, however, a Riksbank-style reversal in rates seems farfetched in our view, certainly over the next 12 months. As such, we second guess the bond markets’ expectations and have a preference for overweight duration positions in China and 2-year US Treasuries.
With the FOMC having already used its December meeting to incorporate improved global trade relations into its statement, recent data gives it little reason to change guidance. Consumer spending has remained steady, manufacturing has not improved and core PCE inflation has edged modestly lower. Hence, we expect few changes in the statement that will follow the Fed’s 29 January meeting. The Summary of Economic Projections will be updated in March.
Powell may feel obliged in the press conference to comment on surging asset prices, as some Fed hawks have recently labelled policy as being in a “risky place”, eschewing the fashionable description of it being “in a good place”. But, these tend not to be the kind of worries that lead to policy action.
As expected, the ECB decided to keep the deposit facility rate unchanged at -0.50% at its January meeting. Meanwhile, the second ECB press conference hosted by President Lagarde – much like the inaugural one – yielded no major surprises. She reiterated the need for a prolonged phase of highly accommodative monetary policy, while underlining that the ECB stands “ready to adjust all of its instruments, as appropriate”.
What is more, despite seeing “some signs of a moderate increase in underlying inflation” and stating that downside risks to the Eurozone growth outlook had become “less pronounced”, she reaffirmed that the Governing Council continues to expect keeping policy rates at “present or lower levels” until it sees the inflation outlook convincingly converge to the current medium-term inflation target of “below but close to 2%”. In short, the ECB has retained an easing bias.
On the negative rate policy, Lagarde stated that it “had helped boost employment across the region”, that she wouldn’t want to draw conclusions from the recent decision of Sweden’s Riksbank to exit negative rates, and that the strategy review would look at the negative side effects of the policy.
China’s policy rates have remained unchanged since the 5bps cuts in the 1-year MLF and PBoC 7-day reverse repo rate of, respectively, October and November. The loan prime rate, which, from this year is also the new benchmark for pricing existing floating-rate loans (besides new loans), has also remained unchanged since November, at 4.15% for the 1-year tenor. Meanwhile, money market rates have drifted lower.
This latter development was helped by the decision to cut banks’ reserve requirements by another 50bps in early January, ahead of the upcoming seasonal increase in cash needs for the Lunar New Year holiday period. This brings the cumulative decline in the reserve requirement ratio (RRR) for smaller banks since Q1 2018 to a whopping 450bps, underpinning the view that the PBoC has engineered a recovery in the ‘credit impulse’ metric mainly through liquidity injections, rather than policy rate cuts.
Looking ahead, and with the recent coronavirus added to the list of downside growth risks, we remain of the view that the easing cycle is not over yet. Notably, Sun Guofeng, the PBoC’s head of monetary policy, recently suggested that there is limited room to further lower banks' RRR. However, we suspect further accommodation is required to avoid a relapse of the credit impulse in coming months, which is in much less expansionary territory than in 2013 and 2016.
The BoJ wrapped up its recent two-day Monetary Policy Meeting with a majority decision to keep the current set of monetary policy instruments in place, in line with market and our expectations. Indeed, there is little appetite at the BoJ to move in either direction: inflation has been persistently sluggish, while financial conditions remain accommodative on the back of yen depreciation and equity market strength; moreover, the cost-benefit trade-off of further easing continues to deteriorate.
We expect that Japanese economic growth will be largely supported this year by fiscal stimulus that is being brought forward at a time when parts of the manufacturing sector are showing signs of stabilization. In particular, in Japan but also in other Asian countries, we note the bottoming out of tech export and production data which typically leads the other sectors.