Easing beyond Draghi

Having disappointed the market at the June ECB meeting, Draghi came out swinging at Sintra. He said additional stimulus, including rate cuts and further asset purchase programmes, would be delivered if the outlook doesn't improve and that such options would be deliberated “in the coming weeks”.  

Furthermore, not only did Draghi indicate his readiness to act but the implication of a consensus amongst governing council members implies that this willingness extends beyond the end of his term. 

The market expects the central bank to restart the corporate sector purchase programme rather than cut rates.  While sceptical of the efficacy of such action, I am inclined to agree that this is moving into “base case” territory. ECB precedent on signalling policy changes suggests the probability has risen sharply.  

Robust investment grade market

Demand for investment grade debt was already strong before this fillip. Issuers were able to come to the market with little or no concessions on price, and inflows into the asset class were steady. Add to the cocktail the prospect of a few hundred billion of price-insensitive demand, record lows on government yields and an increased opportunity cost of not being invested and we have the makings of a very one-sided market.  

Garnish with the cherry of a Trump Tweet that he plans to meet with President Xi next week and now is not the time to be short investment grade credit, at least for the near term.  

Divergence between markets and fundamentals

And yet all of this this macro doom and gloom remains strangely at odds with the positivity evidenced by equity markets and Fidelity’s own Gauges of Economic Activity in Real time (GEARs), both of which point to a more benign view of the world than indicated by interest rates and central bank talk.  

Growth in the US was always destined to normalise after the shot in the arm it received from the fiscal stimulus and indeed the first half of 2019 looks set to return to trend at 2.5 per cent.  

Fidelity’s US GEAR, led by the consumer, has reversed recent weakness while the Eurozone has also stabilised at subdued levels. Yes, capex looks soft and manufacturing is still struggling but leading indicators such as the NFIB survey’s capex intentions have recovered most of the losses seen in the last quarter of 2018 and Chinese leading indicators point to a more robust second half of the year.  

Transitory inflation

The elephant in the room of course is inflation which continues to disappoint on both sides of the Atlantic.  This of course is the air cover by which both the ECB and the Fed can justify pre-emptive action. US Core personal consumption expenditure (PCE) came in at 1.6 per cent in April and the soft core Consumer Price Index print suggests it will fall further in May. Powell has repeatedly argued that much of the weakness reflects "transitory" or "idiosyncratic" factors, and he has pointed to the Dallas Fed “trimmed mean PCE” as a less volatile measure of core inflation.  Here the direction is up not down. 

All of this could therefore portend pain to come further down the line.  A stabilisation in the macro environment that makes central bank action less necessary would unwind the squeeze in fixed income seen over recent months. For now though, this is a risk for another day.  Bad news is good news once again. 

No case for immediate Fed easing

With nearly 100 basis points of cuts priced by end 2020, the bar is certainly higher for Jerome Powell to deliver a dovish surprise than it was for Draghi but he must certainly be feeling the pressure to do so.  In my view the case for immediate easing is weak given still decent growth and the upcoming G20 trade talks.  My hunch therefore is that the Fed stands firm and awaits more data. But, as shown yesterday, bold predictions on central bank actions have a tendency to age quickly.

Kristian Atkinson

Kristian Atkinson