Central banks turn on the taps

Central banks globally have turned on the taps, keeping a lid on interest rates and bond yields. In this month’s video, Investment Specialist, Kirsty Clark discusses the recent round of QE from central banks as dark clouds loom over the global economy.

 

After last month’s flight to safety, global equity markets staged a comeback in September, as the Fed eased monetary policy and the ECB reintroduced quantitative easing.

The MSCI All Countries World Index finished up 2% in US dollar terms, with policy stimulus offsetting weaker manufacturing data in both the US and Europe.

Equities rebound and gold gives back some of its year-to-date gains

UK equities led the gains as the odds of a ‘no deal’ Brexit looked to be diminishing, and we saw sterling strengthen against the US dollar.

Elsewhere, Japan’s Topix performed well, along with the Eurostoxx and Chinese onshore equities, while the S&P500 lagged amid ongoing political and trade uncertainty in the US.

In commodities, gold gave back some of its year-to-date gains. Brent crude finished up overall, but climbed down from a sharp spike immediately following the attack on Saudi Arabia’s oil production early in September.

German bunds and US treasuries lost ground. Rising yields and a rotation out of momentum supported financials and value stocks in particular. Energy also outperformed at a sector level while healthcare lagged.

Overall, investors were cautiously optimistic during the month with loose monetary policy helping to prop up sentiment. September was a month characterised by rising geopolitical tensions and synchronised monetary easing across the globe. With no US-China trade resolution in sight and as concerns of weakening growth weighed on sentiment, central banks globally extended monetary easing to help shore up their economies.

Central banks engaged in synchronised monetary easing

As widely expected, we saw the US Fed cut rates by 25 basis points, but with Fed chair Jay Powell less dovish than some had expected. However, should the data deteriorate, there looks to be scope for further easing from here.

Elsewhere, Brazil slashed rates by half a percentage point. Russia and Turkey also joined in, lowering rates by 25 and 325 basis points respectively. Turkey’s sizeable cut comes after the country’s currency crisis and recession last year.

In the UK, the Bank of England’s Monetary Policy Committee voted unanimously to leave rates on hold as the Brexit deadline looms, but the committee revised down its growth forecasts for the third quarter. The Bank of Japan also stuck to its current rate, but adopted a more dovish tone. Both central banks are leaving the door open for further easing as we head into the final quarter of 2019.

In Europe, the ECB embarked on a raft of monetary stimulus measures amid signs of economic weakness and low inflation. Central bank president Mario Draghi announced a 10 basis point cut in the bank deposit rate to -0.5%, to encourage bank lending. He also announced the reinstatement of the governing council’s asset purchase programme from the 1st of November. The central bank will make purchases worth €20 billion a month for as long as deemed necessary. The markets had anticipated the reintroduction of asset purchases, although the monthly limit undershot some predictions.

Perhaps more surprisingly, the ECB also made amendments to the terms of its third round of Targeted Longer Term Refinancing Operations or TLTRO III as it’s been dubbed, a move aimed at further supporting the banking sector.

Essentially, the more that banks lend into the real economy, the more favourable the central bank’s lending conditions.

From the end of October, qualifying banks will be able to benefit from a so-called tiering system which enables them to borrow at lower, possibly negative rates (in effect, earning interest on borrowings), while also being able to deposit some of their excess reserves, an ‘exempt tier’, for free.

It is ECB president Mario Draghi’s swan song before handing over the reins to former IMF chief Christine Lagarde.

Supporters have praised the central bank’s innovative approach to tackling anaemic growth in the region. However, the latest easing measures were also met with strong resistance from some of the more hawkish members of the ECB’s governing council, concerned about the unintended consequences of chronically-low interest rates.

Alongside monetary easing, there have been growing calls for countries to embark on greater fiscal stimulus to help reignite growth, not least in the euro area.

Governments listening to calls for greater fiscal stimulus

In Europe, Mario Draghi has repeatedly called on nations with fiscal headroom to use it. France has declared that it will cut taxes by more than 10 billion euros next year, and the country’s finance minister has called on Germany to follow suit and loosen fiscal policy.

With growth slowing and Germany heading into a recession, pressure has been mounting on the German government and finance ministry to deviate from its long-standing zero-deficit policy, and there are signs that the country is softening its stance, with Chancellor Angela Merkel acknowledging that reforms and finance policies had to take the burden off the ECB.

The IMF has also urged the German government to initiate growth-enhancing investments, so it will be interesting to see if Christine Lagarde maintains this line when she assumes her new role as central bank chief in November.


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