Global Daily – Swift hike cycle unlikely despite Nowotny remarks

by: Nick Kounis , Bill Diviney , Arjen van Dijkhuizen

ECB View: Nowotny has a history of putting markets on the wrong foot – ECB Governing Council member and Austrian central bank governor Ewald Nowotny suggested that the central bank could hike by 20bp when it starts to move interest rates higher. The general view in financial markets (including our own base scenario) has been that the ECB would move up its deposit rate in steps of 10bp. There was a modest reaction in financial markets, with the belly of the government bond curve in particular selling off, while the euro strengthened.

We would describe Mr Nowotny as having a hawkish tilt rather than being an outright hawk. However, perhaps more importantly, he has a history of putting markets on the wrong foot with his remarks. A couple of occasions stand out. In October 2013 he signalled that the ECB would not react to the strong euro by cutting interest rates. In November 2013, the ECB cut interest rates. In March of last year, the Austrian official suggested that the ECB could raise interest rates before ending QE, which also pushed up the euro and bond yields. In the weeks thereafter, other ECB officials lined up to deny this and the central bank’s intention to raise interest rates well past the end of asset purchases has remained embodied in its forward guidance.

The message coming from multiple members of the Governing Council is that the exit process will be extremely slow, given weak underlying inflationary pressures. If anything, the message has generally become more dovish recently, as ECB officials have been concerned that slack in the labour market might be greater than currently estimated and that wages may remain subdued for longer. Against this background, early or quick rate hikes seem unlikely to us.

We continue to think that the ECB will set out a clear roadmap for the end of its asset purchase programme in June/July. We expect a tapering period of 6 months (3 months EUR 20bn p/m and 3 months EUR 10bn p/m). We do not expect the first rate hike to follow until the second half of next year (10bp in September and another 10bp in December). We expect the ECB to maintain or even strengthen its forward guidance on interest rates when it announces a wind-down of net asset purchases (Nick Kounis).

US Rates View: Yield curve inversion by late-2019 – Following our change of view to expecting four rate hikes from the Fed in 2018 (see our Daily from yesterday), we have made some modest adjustments to our US Treasury yield forecasts. We now expect a more front-loaded increase in the 2y yield, with it reaching 2.70% in Q3, and peaking at 2.90% in Q4 (previous: 2.50%, 2.60% respectively), as markets price in a quarterly pace of rate hikes. Our revision to 10y yields is more modest, however, with it now rising to 3.10% in Q3, and peaking at 3.20% in Q4 (previous: 3.00% in both Q3 and Q4). We therefore expect a more rapid flattening of the yield curve, with the 2s10s falling from around 50bp at present, to 40bp in Q3 and 30bp in Q4 (previous: 50bp, 40bp). Moreover, we now expect the curve to invert slightly by the end of our forecast horizon in Q4 19, as markets begin to price in slower growth on the back of the fading impulse from fiscal stimulus, and the lagged pass-through of tighter monetary policy. (Bill Diviney)

US-China Trade Tensions: A small step forward – This morning, financial markets reacted positively to China’s president Xi Jinping’s speech at the Bo’ao Forum for Asia, the Chinese equivalent of the World Economic Forum in Davos. While Xi’s speech offered limited new policy initiatives, he confirmed China’s aim to open up its financial sector, lower tariffs and boost imports, reduce foreign-ownership limits on manufacturing and improve protection of intellectual property. Without mentioning Trump by name, these measures are in line with (part of) the US administration’s demands – indeed, Xi implicitly responded to a recent tweet from Trump that China should lower import tariffs on cars. Moreover, they would fit in China’s strategic reform plans, enabling Xi to offer concessions without losing face domestically. Meanwhile, vice premier Liu He – responsible for economics and finance – was quoted as saying that China had rejected a US demand to end the granting of subsidies to high-tech industries related to its ‘Made in China 2025’ initiative. Liu added that the US had rejected a proposal from China to reduce the bilateral deficit by USD 50bn (half of the USD 100bn asked for by Trump) by boosting imports and opening up the financial sector at a faster rate. While these developments could be perceived as setbacks, in our view it suggest that both countries are slowly working to reach some form of negotiated (short-term) settlement. However, given US concerns over China’s ‘Made in China 2025’ industrial policy goals of supporting national champions is strategic, high tech sectors (as confirmed by China hawk Pete Navarro yesterday), we expect these more controversial issues to linger for longer. (Arjen van Dijkhuizen, Bill Diviney)