13th March 2019
One of my core themes of late has been the growing divergence between the markets’ expected path of policy easing from developed market central banks, and the actual outlooks of these institutions themselves.
I would stress that central banks have been moving cohesively to a more dovish stance for the last couple of months now and responding to the deterioration in economic data points. However, markets are thinking two steps ahead and positioning themselves around how they see these dynamics way a head of the curve. Central banks, as we have learnt, tend to be far more reactive beasts and their actions often lag market pricing emphasizing the divergence of market and central bank policies.
In the US, the Fed is in no rush to hike rates and we are still waiting on the China US to hash out a deal. It will be interesting to see how they negotiate the ability to print money in the deal as devaluing one’s own currencies has an impact.
Here in the Australia, the RBA has recently downgraded its outlook for the Australian economy, with the main concern being further declines in property prices together with lower retail sales. Furthermore, many analysts are worried that the excellent run in the equity market in 2019 has over reached and a sudden correction would lead investors into less volatile assets. The dynamics of poor growth, ailing credit, and falling house process are well known and we have now seen more and more leading economists changing their view and they are now calling for interest rate cuts this year. We have our concern of the effectiveness of such cuts as the banks probably would not pass on the lower rates and the only benefit, we can see would be a weakening of the Australian dollar.
It comes as no big surprise that the ECB told the market last week that they have no intention to increase interest rates and that they have reduced their growth outlook for the European economies down from 1.7% to 1.1%. In addition, we have already heard for the past couple of months that the Central Bank is once again very active in supporting liquidity in the market and as a good friend of mine and one of the biggest market makers on the Frankfurt Stock Exchange, Arthur Brunner is telling me that it starts to smell like we are back in crisis mood again. In particular, the Italian banking system would be once again one of the flesh points should the situation deteriorate in the next couple of months. There is also some talk again, that the two German mega banks, Deutsche Bank and Commerzbank are having discussions about a possible merge. However, we believe that the current rally in the European Government bond yields is overdone and rates at the long end of the yield curve are too low and are due to recover soon.