I never promised you a rose garden

The ECB delivered at least as much as was expected to investors on Thursday adding further stimulus to the flagging euro area economy. Cutting interest rates further into negative territory and starting a 20 billion euro a month bond purchase programme, in an open-ended commitment. The ECB expects interest rates to remain at this level or possibly lower (not ruling out further cuts) until the inflation outlook “robustly converge to a level sufficiently close to but below 2% within its projection horizon, and such convergence has been persistent.”  Next week it is the turn of the Federal Reserve to add further stimulus as economists expect a cut in interest rates by 25bp.

In the Chairman’s post-announcement press comment’s, he did refer to Brexit in a circuitous way referring to geopolitical tensions influencing the decisions taken. We have discussed the possibility of the ECB looking beyond bonds, maybe including equities, due to scarcity and value in the bond market. In amongst the first question Mario Draghi received was on this very point. Had they looked at additional types of assets aside from government bonds? In a long and rambling response, Mr Draghi seemed to avoid answering the question but instead focussing on the consensus that the ECB needed to act. At least he did not deny the possibility.

The reaction of the capital markets was fairly standard; the euro fell as equities and bonds rallied. Overnight concessions between China and the US further encouraged equity markets to believe a thawing in the trade war is occurring. Trade secretary Steven Mnuchin adding to hopes announcing that Trump could declare a trade pact “at any time”.

The garden looks rosier from a headline news perspective, at least for now. The question remains as to whether these additional measures will have the same positive impact they have historically. Central banks head further down the road of increased risk-taking by speculators, in most likelihood adding to worlds pile of debt. In the hope, the global economy will eventually grow fast enough to start to reduce this debt burden. From a macro point of view, there continues to be a recovery in the US economy compared to expectations. Consumer spending remains robust as interest rates and unemployment levels remain supportive. Global growth held up better than expected in the 2nd quarter, according to Capital Economics research. The US yield curve has started to steepen once again as the global economy shows signs of stabilising.

The ECB’s first purchase program started at the end of the first quarter in 2014. Not suggesting it will have the same impact it did then, but on that occasion, euro area equities rose approximately 20 pct in the following year.

Posted on September 13, 2019 .