The last week’s market highlights:
Quote of the week:
“The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does.”— Mario Draghi
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 4Q 2019 Outlook :
- U.S. economy: Still seeing signs of growth
- Global economy: Downward pressure but no recession.
- Policy watch: Markets expect more easing
- Fixed income: Opt for high quality, longer maturity
- Equities: Get defensive, stay invested
- Asset allocation: While cautious, still prefer emerging-market bonds
Policy watch: Transferring le bâton to Ms. Lagarde
According to author and poet Maya Angelou, “At the end of the day, people won’t remember what you said or did. They will remember how you made them feel.” That quote may apply to many folks, but not to Mario Draghi, who conducted his final meeting as president of the European Central Bank (ECB) on October 24.
In fact, Draghi will be remembered for the many things he did as head of the ECB—such as cut interest rates nine times without raising them once, while doubling the size of the ECB’s balance sheet through quantitative easing (QE).6 Draghi has also forged a place in central bank lore. In 2012, at the height of the eurozone crisis, he said ”the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
But last week, he made no such bold predictions or announcements. And the ECB made no waves, following the script written at its September meeting by pledging to:
- Maintain a record-low -0.5% deposit rate. Rather than pay interest to commercial banks on their overnight deposits, the ECB will charge them for holding their cash.
- Anchor this rate at its current level (or lower it) if the region’s inflation outlook fails to improve.
- Ease borrowing terms for banks to promote business and consumer loans.
The ECB also confirmed it will restart quantitative easing (QE) after pausing its asset-purchase program in December 2018. Beginning in November, the central bank will buy €20 billion of bonds every month “for as long as necessary.”
On November 1, Draghi will be replaced by Christine Lagarde. A lawyer by training with no direct experience setting monetary policy, she nonetheless brings valuable experience as former managing director of the International Monetary Fund and as France’s finance minister during the 2008 global financial crisis. She‘ll need to use all her financial and business acumen, as the ECB faces several challenges:
- Divisions amongst the ranks. Several ECB officials have previously opposed reviving QE. One argued that QE should be unleashed only when the eurozone faces a high risk of deflation, which doesn’t exist now. Another feared the ECB would be left without ammunition if the economy were to slip further. Yet a third didn’t think the growth outlook was weak enough to justify such an aggressive tactic. Such dissent can weaken the ECB’s credibility and make it more difficult for Lagarde—who has expressed dovish views in the past—to ramp up stimulus efforts.
- Gloomy eurozone growth. Markit’s composite purchasing managers’ index (PMI) for the eurozone—measuring both manufacturing and service-sector economic activity—edged up to 50.2 in October, just above the 50 mark separating expansion from contraction. Looking under the hood of the composite, a further steep decline in the region’s manufacturing output was accompanied by one of the weakest service-sector expansions since 2014. In addition, consumer inflation rose just 0.8% year-over-year in September, marking the eurozone’s lowest 12-month increase since 2016.7
- Trouble ahead, trouble behind. Uncertainty over Brexit, a slowing global economy and the U.S./China trade war have heaped further pressure on the ECB.
In the seven weeks leading up to the ECB’s final 2019 meeting (December 12), Lagarde is likely to begin banging the drum for European governments to amp up fiscal spending, as Draghi has repeatedly done. And unless the eurozone economy rapidly catches fire—an unlikely scenario given its current malaise—the ECB may soon cut interest rates even further into negative territory.
What is likely though, in Draghi’s mind, is that Lagarde will do a good job. “She knows better than anyone else what to do and what to say” he declared during the ECB’s press conference. One respected economist echoed his sentiments, opining that Lagarde is the “right person, perhaps the only person, to take this baton forward.”
Policy watch: Will the Fed go fourth?
Just as no surprises emanated from the ECB policy meeting, we anticipate no bombshells from the Federal Reserve when it gathers on October 30. The Fed is widely expected to cut interest rates by 25 basis points for the third time in 2019, with the market-implied odds of such easing hovering around 90% as of October 25.8
The “dot plots” from the Fed’s September meeting indicated that a majority of members didn’t believe further accommodation would be warranted in October. So what’s driving the Fed to cut rates again? Subpar September economic data reported after the Fed’s last meeting. This includes (1) slumping manufacturing PMIs; (2) below-consensus job and wage growth; and (3) declining retail sales, worrisome because consumer activity makes up about two-thirds of the economy.
Potentially complicating matters for the Fed is that the global backdrop has improved in October, albeit slightly. U.S. PMIs remained in expansion territory, President Trump canceled an October 15 tariff increase and Brexit tensions have temporarily cooled. Taken together, these developments could provide cover for the Fed to pause in December. And that’s what markets are expecting, placing just a 28% chance of a fourth rate cut in 2019.9
Nonetheless, the Fed may be wise not to send a strong signal that it’s done trimming rates for now. December promises to be a fraught month, with the fuse still lit on another tranche of tariffs and the uncertainty of a potential general election in the U.K. Additionally, a rise in the U.S. dollar, which often accompanies a less-dovish Fed, would hurt U.S. exporters, because it means less-competitive prices for their products in other countries.
At his press conference this Wednesday, Fed Chair Jerome Powell may best be served by donning a juggler’s outfit, balancing a positive tone on the U.S. economic outlook with the possibility that the Fed could ease again in December—all while remaining “data dependent.”