Macro insights

ECB cuts rates, Fed expected to follow; Brexit political drama continues and oil prices spike

The US Federal Reserve’s interest rate announcement and press conference on Wednesday evening will dominate financial markets’ focus this week. We remain of the view that the Fed will ease monetary policy at this meeting, reducing the Fed Funds Rate by 0.25% to 1.75%-2.00%. Market expectations are overwhelmingly of this view - however, we note that just under one-third of analysts polled by Bloomberg expect the Fed to remain on hold at this meeting. A brief review of the economic landscape illustrates why some doubt there will be a cut this week, with the S&P 500 index within one percentage point of all-time highs and core Consumer Price Index (CPI) inflation at an 11-year high of 2.4%. Nevertheless, we believe that with global manufacturing weakness spilling into US activity and the prospects of renewed trade tensions in the final months of the year, fragility in financial conditions will leave the Federal Open Market Committee (FOMC) unwilling to suggest that its role in supporting the economy is over. As a result, we expect participants’ forecasts of the Fed Funds Rate to suggest one more cut ahead. We anticipate this to be delivered in December, broadly consistent with market expectation. Thereafter, markets currently price a 68% chance of at least one more cut in 2020, which we do not envisage. September’s Empire State and Philadelphia Fed surveys, released on Monday and Thursday, will be the latest guides to domestic manufacturing conditions.

The European Central Bank (ECB) implemented a comprehensive monetary policy package at its September meeting last week. This included a cut to the deposit rate and introducing tiering, a change to the forward guidance, easier conditions for the latest series of targeted longer-term refinancing operations and a small but open-ended quantitative easing programme (QE). Overall, the surprise was mainly from the open nature of QE, as the monthly amount of €20bn was rather disappointing, while the other changes were broadly expected. No explicit details were revealed around the breakdown of the asset purchase programme, beyond the fact that the ECB is extending the possibility of buying assets with yields below the deposit facility rate to all private sector purchase programmes. We see this as a way of creating some additional room to skew the programme towards a smaller share of sovereign bonds. But the fact that there was no appetite for a discussion on limits is clearly problematic in our view. It was probably a compromise made to the hawks and it literally transfers this complex discussion to the next ECB President. The next team will also have some latitude in determining what constitutes “robust convergence” of inflation to their target, and what it means for this convergence to be “consistently reflected” in underlying inflation dynamics. That’s why the current division in the ECB Governing Council matters - the Council members who last week opposed QE may decide to take a microscope and look to detect inflation pressure very early. We would also highlight that the ECB’s communication is increasingly lacking consistency. ECB President Mario Draghi repeatedly emphasised that fiscal policy should become its main instrument (“it is high time that fiscal takes charge”). If even central bankers now believe the fiscal element of economic policy should take the lead, while recognising that additional monetary stimulus can come with adverse effects – to the point that the deposit rate cut is “mitigated” by tiering – then the question arises of whether the monetary push is going to be a net positive. This week is relatively light in terms of economic data with only the German ZEW financial market survey tomorrow. But it might be interesting in terms of politics, as Germany will unveil a package of climate protection measures on September 20, while there will be the last round of talks in Spain to form a new government. We cannot rule out a last-minute agreement between left-wing party Podemos and the Spanish Socialist Workers’ Party PSOE, but if no new government has been elected by Parliament by September 23, a general election will take place - likely on November 10.

In the UK, even the Bank of England (BoE) announcement this Thursday will struggle to tear financial markets’ focus from the ongoing political drama engulfing the UK. The BoE’s decision is likely to leave monetary policy unchanged – and the interest rate at 0.75% - as economic data continue to suggest that a ‘steady as she goes’ policy is appropriate. The latest tick-up in wage growth to 4.0% will still cause angst to some Monetary Policy Committee (MPC) members. However, softer employment growth and Wednesday’s CPI inflation release for August - that is likely to show inflation around the BoE’s 2% target - suggests no immediate pressure to change policy. Indeed, financial markets have lowered their expectation for a rate cut this year and now conclude – like us – that policy will remain on hold for most of this year and next. But the outlook will be determined by any resolution of Brexit – and for now this remains remote. Prime Minister Boris Johnson appears to be making renewed efforts to arrive at a deal with the European Union and will meet with European Commission President Jean-Claude Juncker today. The UK Supreme Court’s decision on whether the prorogation of Parliament was legal is expected tomorrow morning. In addition, the party conference season kicks off with the Liberal Democrats – who have recently shifted their policy on Brexit to an immediate revocation of Article 50 if they were to gain power. The conference season should mark a period of pre-election campaigning from the parties, and provide fewer developments on the Brexit front. That said, Brexit will remain not far from the front pages.

Oil prices spike on coordinated drone attacks on Saudi oil facilities. So far, the disruption is estimated to be around 5% of global oil output - or half of Saudi Arabia’s - and it remains uncertain how long it will take to get the oilfields that were attacked functioning again. Saudi Aramco reported that about 5.7 million barrels per day (mbd) of oil supply was impacted. Putting this in a historical context, Iraq’s invasion of Kuwait in 1990 affected 4.3 mbd - almost 7% of global output at the time. The US reacted by immediately releasing some strategic reserves and we could expect to see some inventory drawdown from Saudi Arabia and the Organization of Economic Cooperation and Development. The price action we saw this morning, with Brent spiking 8.5% to touch $66, would not move the dial from a macroeconomic point of view. Rather, the evolution of the geopolitical environment will play a significant role going forward. The alliance between the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC members, known as OPEC+, was broadly expected to announce production cuts to help balance the market going into 2020, though this supply shock might force them to adapt their strategy in the short term.

Turkey cuts rates further and there could be more to come... Just as the ECB surprised the markets in its September meeting, the Central Bank of the Republic of Turkey (CBRT) surprised markets in its own way. The CBRT delivered another massive rate cut - one-week repo rates were cut by 325 basis points (bp) to 16.5% after an earlier 425bp cut back in July. Its dovish statement, which emphasised the recent inflation deceleration, as well as downside risks looking forward with expectations of the inflation rate ending the year below the current official forecast of 13.9%, certainly keeps the door open for further easing. The inflation rate decelerated sharply from its peak above 25% to 15% in August and is likely to continue to decelerate in September and October - bar a significant and persistent spike in oil prices. This could offer a window of opportunity to the CBRT to further cut rates, especially if major developed markets central banks are doing so as well - we expect the Fed to cut rates in September and December this year. We expect the Turkish one-week repo rate to fall to 15% by year-end. Given the political preference for policy mix accommodation, through low rates and fiscally supported economic growth, there is always a risk of larger cuts. The Turkish lira reacted positively after the CBRT’s decision, appreciating to 5.66 against the US dollar from 5.75 last Friday. Obviously, Turkey’s structural issues have not vanished. The recent drone attack on the Saudi plant is another unfortunate reminder - such an event could threaten the recovery path of the Turkish economy, given its dependence on oil prices. Inevitably, the lira weakened and currently trades around 5.72 to the dollar. As always, the fine tuning of policy support will be of major importance in the trajectory of the currency ahead.


Upcoming events

US: Empire State manufacturing survey (Monday), industrial production (Tuesday), FOMC decision and projections (Wednesday), second quarter current account balance, Philadelphia Fed index, existing home sales (Thursday)

Euro Area: German ZEW survey (Tuesday), Euro Area preliminary consumer confidence, German Producer Price Index (Friday)

UK: Liberal Democrats Party Conference (Monday and Tuesday), Supreme Court appeal on Parliament prorogation (Tuesday), Consumer Price Index (CPI), Retail Price Index (Wednesday), MPC announcement, retail sales (Thursday)

China: Industrial production, retail sales, unemployment (Monday)

Japan: CPI (Friday)

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