ECB View: Draghi validates market rate expectations – There were four important takeaways from the ECB Press Conference.
First of all, the ECB remains confident in its positive outlook for economic growth. ECB President Draghi said the central bank judged that economic indicators were stabilising, and were at levels consistent with solid economic growth. Still, it sees ‘prominent’ risks due to the rise of protectionism.
Second, the ECB slightly upgraded its language on inflation, saying that ‘domestic cost pressures are strengthening and broadening amid high levels of capacity utilisation and tightening labour markets’, with ‘broadening’ being the new element.
Third, despite its confidence that inflation will rise, Mr. Draghi emphasised that ‘significant monetary policy stimulus is still needed to support the further build-up of domestic price pressures and headline inflation developments over the medium term’. Indeed, he validated market expectations for an autumn 2019 rate hike, which drove government bond yields and the euro lower.
Finally, the ECB did not discuss reinvestment policy or even when to discuss it, though the ECB President noted that the capital key had to be respected. This seems to rule out the possibility that the proceeds of maturing bonds in one jurisdiction will be reinvested in other.
Our baseline scenario remains that given ongoing subdued inflationary pressures, the ECB will hike in December 2019, which is a little later than it is currently signaling. (Nick Kounis)
Global Trade: A positive step in US-EU trade relations, but not out of the woods – European Commission President Juncker and US President Trump agreed overnight to enter into negotiations over trade policy, and to hold off from any further tariff imposition unless one of the sides pulls out of negotiations. The two sides also agreed to consider rolling back the US’s steel and aluminum tariffs against the EU, and the retaliatory tariffs the EU has imposed. The agreement is light on detail, beyond vague commitments from the EU to import more soybeans and LNG from the US, but for President Trump, it is all about the optics, and his voters will likely view this news positively.
The agreement to postpone tariffs has come as a relief for markets, and equities and bond yields have risen accordingly. However, investors should continue to tread carefully, because the US was also negotiating with China some months ago, and those talks ultimately broke down with tariffs implemented. The chances of success with the EU are higher, as the source of tensions is less deep-rooted (with China, there are more strategic concerns over its ambition to rival the US in the tech sector). But a positive outcome is by no means certain. Meanwhile, there continues to be little sign of serious negotiations with China, where the threat of a further escalation in tit-for-tat tariffs remains serious.
With that said, our base case is that the direct macro impact of trade tariffs will be limited, and we expect the Fed to continue hiking in the interim (we project four further 25bp hikes). The chief risk to our scenario is if uncertainty over trade policy starts to significantly dampen business confidence, and in turn investment. Should that happen, we believe the Fed would likely pause in its rate hike cycle. (Bill Diviney)