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The Federal Reserve has signaled it will abstain from raising interest rates for the rest of the year in the face of decreasing economic momentum in the US and abroad, sealing a sharp, dovish shift in monetary policy headed by chairman Jay Powell. At the conclusion of a two-day session in Washington, US monetary policymakers determined to maintain the target range for the Federal Funds rate between 2.25 percent and 2.5 percent, where it has been since December, as was predicted by economists.
Whereas late last year the median interest rate forecast of Fed officials implied two additional increments in 2019, it now implies none, as US central bankers also reduced their predictions for US economic growth this year to 2.1 percent from 2.3 percent in December. The result of the meeting suggested Fed officials have become sceptical of the economy’s capacity to withstand the roughly 3 percent growth rate achieved last year while it enjoyed the Trump administration’s tax cut-driven fiscal stimulus.
The determination to maintain rates constant for the foreseeable future also exposed their lingering — and rising — concerns about risks related to the UK’s departure from the EU and the US-China trade conflict. Meanwhile, the US dollar depreciated, which is expected to be greeted with satisfaction among US exporters and some central bankers around the world, principally in emerging markets, where there have been significant uncertainties about the impact of US monetary tightening on their currencies.
Sterling is giving a poke in the eye to the Efficient Market Hypothesis. With the exchange rate neglecting to swallow the prospect of the UK hurtling out of the EU without a deal. Such a result cannot be ruled out. If anything, the risk is accelerating, considering the latest twists in British politics. A no-deal exit is a “central scenario”, in the words of the French foreign minister, and few outside of the hardcore “Brextreemists” believe it would leave the UK economy unscathed. And yet the pound has scarcely changed, still held around $1.32 to the US dollar. This reveals two phenomena: investors’ rather touching faith that British politicians will yet preserve the national interest, and a fall in the US currency. It is hard, if not insurmountable, to find a single fund manager who thinks a no-deal Brexit will pass, which is why it is not being factored into the pounds exchange rate already. Such certainty has encouraged sellers to reel in their bets and encouraged the pound to become one of the best-performing currencies in the world against the dollar so far this year.
Some of the strength in the sterling-dollar exchange rate, however, is a mirage. Yes, the pound was impassive when parliament’s Speaker undertook to rule out a repeat vote for MPs on the prime minister’s favoured Brexit deal. And Sterling was unyielding when Theresa May on Wednesday insisted on remaining with her chosen course. But a glimpse at short-term fluctuations in other principal currencies indicates that the pound has been upheld by the vulnerability in the dollar. The euro shot higher against the US currency on Wednesday after the Federal Reserve backed even further aside from raising interest rates.
The yen gained and emerging-market currencies headed off to the races. Yet Sterling almost stood still, a triumph, considering the farcical state of the nation’s politics. Yet it still dropped against the euro, and it is obviously lagging behind other currency rivals. But the swoon lower in the dollar is at least affording a meager encouragement. Be under no delusion, however: that protection would almost surely prove inadequate if politicians were to disappoint investors still hoping for an outbreak of common sense.
For emerging market investors, 2019 began promisingly. The US Federal Reserve has kept back from continuing a series of interest rate hikes that hurt EM assets last year while fears of a more bruising trade war between the US and China have abated. However, a January rally in the bonds and stocks of many developing economies has since waned. Given the more benign backdrop delivered by a change in policy from the Fed, the deterioration of EM markets to continue their momentum may rest on the evidence that investors opened the year with a good deal of exposure to them.
According to the Institute of International Finance, an industry association that gathers EM data, the IIF examined the balance of payments data from 23 emerging economies, broken down by cross-border flows and moves in asset prices, to determine how the value of foreign holdings of each countries’ securities, such as equities and bonds, have changed. Their research underscores that a decade of quantitative easing by Western central bank triggered a torrent of offshore capital into EM assets. Between 2010 and 2018, investors poured capital into most EM countries, with only Russia and Hungary missing out over the cycle.
Although the effect of fluctuations in the prices of EM assets was less uniform, the clear trend was that the value of foreign holdings of securities, as a share of total GDP, surged across EMs. And despite last year’s rout in EM assets, most foreign investors received the hit to valuations without diminishing their risk. The IIF’s data indicate that flows were moderately negative at best. The analysis reveals that fund managers went into the year with substantial exposure to EM assets, placing a restraint on their hunger for more. Until there are signals that global growth, and the Chinese economy, in particular, can gain momentum, the EM rally may well remain on pause.
Oil prices touched their highest level this year on Thursday, exceeding $68 a barrel as traders bet the market would tighten with US sanctions crimping supplies from Venezuela and Iran. Doubts remain, however, whether prices can rise much further given record US shale industry output.
Brent crude, the international benchmark, gained almost 2 per cent in early trading to reach $68.14, but prices later reversed to near $67 a barrel, weighed down in part by forecasts suggesting Opec would need to maintain deep output cuts this year to keep the market supported. Traders said the oil market, while showing signs of breaking higher, remained caught between two big competing forces that have dominated the industry so far in 2019. Opec, led by Saudi Arabia, has slashed production to try and support prices after they plunged towards $50 a barrel in the fourth quarter of last year, while US sanctions are removing more barrels from Iran and Venezuela.
At the same time, surging production in the US has largely capped price gains despite Opec’s efforts, with the four-year high of $86 a barrel hit last October – shortly before prices plunged – seemingly a distant memory. Concerns about the health of the global economy have also weighed, with the focus on trade talks between China and the US, the world’s top two oil consumers.
The week begins in the UK with the question: What next for Theresa May and her Brexit deal? As Britain’s prime minister faces calls from Conservative MPs to resign, while her own ministers have debated how to supplant her. An extraordinary cabinet session will take place on Monday before a key parliamentary vote on other Brexit options after ministers admitted Mrs May’s deal that it was improbable ever to win MP’s consent.
Economic data: There is little in the way of Tier One economic data or news. The final evaluation of US third-quarter gross domestic product on Thursday is expected to reveal the economy expanded at 2.4 percent annually. US consumer spending and trade deficit figures are similarly out this week.
Canada is on Wednesday predicted to report GDP for January rose 0.1 percent after a 0.1 percent dip in December.
In the UK, the final version of fourth-quarter National Accounts are released on Friday, with growth figures set to be unchanged at 0.2 percent. Whilst German and Japanese unemployment figures are also out this week.
Confronted with slowing economic growth, uncertain politics and wobbly markets the European Central Bank reliably came to the rescue the week before with new stimulus measures and a postponement of the start to any normalisation of interest rates. Yet, despite the soothing tonic markets were initially disturbed. This was partially because of the sharpness of the ECB’s downgrade to this year’s growth forecast from 1.7 percent to 1.1 percent. But it was also a response to the downbeat rhetoric of ECB president Mario Draghi, who portrayed the Eurozone as being in “a period of continued weakness and pervasive uncertainty.” Therefore the school-of-thought gaining traction is that a low-growth, low-inflation situation in the Eurozone, along with a negative deposit rate and extensive central bank liquidity, emulates a conspicuous correlation to post-bubble Japan. Thus, is the Eurozone, heading for a simulacrum of Japanification?
Admittedly. Whilst the Eurozone economy has left behind its “normal” expansion path following the global financial crisis and has fallen into the Japanification territory that has characterised that country for the past quarter century. The continental Europeans has not been tormented with Japanese-style deflation. And whilst Japan’s gross public sector debt remains at close to 240 percent of the gross domestic product. Whilst Eurozone public debt is down to 86 percent from approximately 92 percent five years ago. Yet the demographic similarity is intriguing. Japan has the world’s oldest people. Its population dwindled by 1m between 2012 and 2017, a measure comparable to the populace of Stockholm, and is anticipated to diminish by 25 percent in the next 40 years. The Eurozone is now traveling in the same direction, with a working-age population that began to dwindle in 2009. Shrinkage is forecast to advance notwithstanding continuing immigration.
The controversy with the analogy, it implies is that the Eurozone is not a homogeneous bloc. Southern Europe, notably Italy and Greece, diverges from the north and has arguably performed much worse than Japan. In addition, impressions of Japanese stagnation have been warped by demography. Yet, perhaps the most conspicuous difference stems from Japan’s particular structural dilemma, whereby the society has depended on massive government deficits to negate the deflationary impetus of undue private sector savings so as to try to sustain domestic demand.
Because of fears about excessive government debt policymakers embark on periodic consumption tax grabs to correct the fiscal position. Another is expected later this year, which causes the economy’s growth trajectory to be bumpy. Whilst, in the long run, this uneven movement of financial support is unpredictable. Yet perhaps the Eurozone has its own variant of this malady. The bloc runs a sizable current account surplus reflecting northern Europe’s propensity to save more than it invests. It also possesses a faulty monetary union that produces an over-competitive exchange rate to Germany and other northern Europeans. Their fiscal conservatism militates against any undertaking to tackle the North-South imbalance that derives from these ramshackle monetary provisions.
The consequences of this are that the Eurozone will continue to be over dependent on the rest of the world for demand stimulus, and thus this muted Japanification will become a more familiar word in the European vocabulary; whilst populism will similarly advance, and interest rates will remain lower for much longer than most people anticipate.
The near-paralysis in the UK parliament over Britain’s withdrawal from the EU has kept alive the risk that the country tumbles out of the bloc without a withdrawal agreement at the end of March. Regulators responsible for capital markets spanning both the EU and the UK have been obliged to step up attempts to minimise disruption in the event of a “hard” Brexit. With brokers, banks and investors all anxious for leadership on what will take effect in some of the key sections of trading should Britain leave the EU on March 29 without a settlement.
The EU has recognised derivatives clearing-houses as equivalent but not the exchanges that run them, notably ICE Futures Europe and the London Metal Exchange. That potentially means the futures contracts that are traded on an exchange will, after a no-deal Brexit, be designated as over-the-counter (OTC) derivatives. That overnight switch will incur higher margin requirements and may trigger tougher reporting obligations for users normally exempt from such activity. Collateral, a crucial factor in trading remains a potentially thorny issue in the event of a hard Brexit. One problem lies in the fact that sterling-denominated collateral, such as Gilts, is adapted to back derivatives trades. So an abrupt fall in sterling and which some think will happen if the UK crashes out of the EU would mean that traders have to stump up more collateral.
Further complexity is that trades settled in the Eurozone need to be upheld by high-quality collateral, such as debt sold by member states. That obligation must likewise be exchanged on a EU-sanctioned market, possibly ruling out a London-based venue. Regulators had been formulating a bold reform of regulations for European markets, known as Mifid II, for years before the UK’s Brexit referendum. One of the regulators’ intentions was to instil more clarity into markets, adding an attempt to push more stock and bond trading on to electronic trading venues.
However, precisely calibrated tests created to establish whether a security should be on an exchange will be nullified by a hard Brexit, because it focusses so much enterprise in London. The European Securities and Markets Authority last week announced it would temporarily defer the thresholds. But which rules will apply immediately is unclear, indeed even to the regulators.
The dollar has been climbing higher this year, and nothing – not even concerns over prospects for the US economy and interest rates – seems adequate to curb it. Last week the dollar index reached its highest close since the summer of 2017 and it is now about 10 percent up from the low it reached in early 2018. However, the currency’s strength appears to be occurring less from an intrinsic conviction in the US currency and more from the vulnerability of its challengers.
The euro is being kept back by weak Eurozone growth; the European Central Bank last week slashed its estimates. Meanwhile, the Bank of Canada has cut its growth forecast and Australia must contend with a deceleration in China, its main trading partner as seen by lower-than-forecast Australian gross domestic product figures last week. The weight of the dollar comes despite the US Federal Reserve’s surprise U-turn at the end of January when it placed more interest rate hikes on standby and said it would be flexible over the extent of its balance sheet.
Moves by other central banks to jettison or defer their intentions to tighten monetary policy are looked at as a reason not to correct the dollar because the Fed ended its rate cycle earlier than supposed. Yet some analysts are still baffled as to why the currency should exchange at such high-cost valuations without the wish for further Fed hikes. Worth monitoring also is the momentum of emerging markets, which have posted vigorous rebounds after last year’s falls. The MSCI Emerging Markets index is up 8 percent this year. As higher dollar makes dollar-denominated debt more expensive to pay off, which could make life troublesome for heavy US-dollar borrowers. Thus a further restraint on emerging markets because of this could yet take place.
Mario Draghi is now sure to perform his eight years as the bank’s president without ever having raised interest rates. He commenced his term by revoking the rises put in by his predecessor Jean-Claude Trichet. He will finish it in November with rates continuing at their present record lows, which the ECB now pledges to continue in store until the conclusion of 2019 at the earliest. That is not the only dovish shift in Frankfurt. The ECB also reconfirmed it would maintain the number of financial securities it had built up as part of its quantitative easing programme until well after interest rates rise — which, given the interest rate announcement, amounts to a postponement for when “quantitative tightening” will begin. It further guaranteed a fresh round of competitive long-term loans to banks prepared to extend lending. This had been foreseen, not least because an early round of loans are about to mature and the central bank would prefer to sidestep a sudden reduction in liquidity. This is all prudent.
The Eurozone economy has moderated in the past six months and is susceptible to continued lethargy. It is notable that Mr Draghi said the risks had moved to the downside and that the policy choices were reached collectively. Seen in a deeper context, however, it is striking how difficult central bankers have found it to bring about the “normalisation” they have been craving. Depending on how you calculate, the past eight years have witnessed three or four aborted tightening turns by the world’s two biggest central banks. In 2011 the interest rate raises helped deliver the Eurozone into a second, self-inflicted recession.
Then in 2015, the US Federal Reserve hiked its policy rate by a quarter-point. Since late 2018, the Fed has again had to temper its tightening plan, vowing flexibility both on lifting rates and diminishing its balance sheet. And this does not include similar situations at smaller central banks. All these judgments, like the ECB’s today, have been judicious. In the vernacular, they have been “data dependent”: central banks have reacted to shifts for the worse in either markets or the actual economy or both. Although taken simultaneously, they present something vaster and more disturbing. Why do central banks find it so painful to eliminate monetary stimulus?
Principally because the economy has turned out, time and again, to be feebler than they hoped. Each time, central bankers have had to amend their mistakes. And while that is welcome, it does not excuse making the underestimates in the first place let alone when it has taken place over and over anew. One wishes that the monetary rethink on both sides of the Atlantic will further curtail the deceleration in Europe and limit one in the US. Yet if growth stabilises at a satisfactory pace, one must still hope central bankers have made enough mistakes to understand that they ought to be less reckless in any future tightening.
The Brexit saga rolls on with EU leaders scheduled to go into a two-day session in Brussels on Thursday on the heels of a potential third ballot on UK prime minister Theresa May’s deal in the House of Commons. The Bank of England and the US Federal Reserve are among several central banks to set monetary policy this week.
International trade secretary Liam Fox has suggested the third Commons vote on Mrs May’s Brexit deal could be pulled this week if the government does not trust it can succeed. The vote is predicted to take place on Tuesday or Wednesday if it does move forwards. The deal has been heavily defeated twice in the Commons after large-scale rebellions by Eurosceptic Conservative MPs and the steadfast hostility of the Democratic Unionist party’s 10 MPs. Mrs May has estimated that if she could win parliament’s backing for her deal this week, she would ask Brussels only for a three-month extension beyond the scheduled departure date of March 29, therefore bypassing any need to take part in the European elections.
BoE rate meeting
The BoE announces its interest-rate decision on Thursday. Expectations for any variation in policy are low and there will be no press conference or inflation report published alongside the decision. Still, traders, investors and economists will scrutinise the minutes of the Monetary Policy Committee’s decision for any signs of how Brexit affects the balance of risks confronting the UK economy. The global economic downturn and public shifts away from any further tightening of monetary policy from the European Central Bank and the Fed will further provide focuses for debate.
Fed rate meeting
Investors and economists are exceedingly confident that the US central bank will leave policy unchanged at this week’s monetary policy meeting, but there will nevertheless be lots to digest – not least minutiae of the Fed’s proposals for its multitrillion-dollar balance sheet. Officials will also revise their forecasts for interest rates, possibly lowering forecasts for further tightening this year amid a wait-and-see approach embraced in January. The Fed has signalled that it will be patient as it considers more interest rate increases, acknowledging muted inflation and slower economic growth.