ECB POSTPONES ITS NEXT INTEREST RATE RISE
In the wake of the Fed’s dovish shift in January, the ECB announced on March 7th that it was postponing any rise in rates to next year. It plans to maintain them at their current levels at least until the end, instead of the summer, of 2019. ECB chief Mario Draghi, aware that markets were already reflecting such a scenario, made the statement to avoid losing credibility.
In parallel, the ECB also announced that following two previous rounds of long-term loans to support the region’s banks in 2014 and 2016, it would be launching a third (TLTRO III), which is set to operate from September 2019 to March 2021. The finer details are yet to come, but the loan conditions will be less attractive than those of TLTRO II, both in terms of maturity, which will be halved to two years, and rates. TLTRO III funds will be provided at rates indexed to the main refinancing rate, whereas in previous rounds, rates could be negative.
Monthly bank lending data indicate that net lending within the eurozone continues to recover, but with TLTRO II coming to an end in 2020, banks’ refinancing terms were set to worsen, especially those of Italian banks, leading to a deterioration in private sector credit conditions.
Alongside these ECB announcements came revisions to forecasts for 2019 growth, down 0.6 percentage points to +1.1%, and to underlying inflation, down 0.2 percentage points to +1.2%. The downward revision to growth appears to be driven more by technical factors (carry-over effect, German car manufacturing disruption) and global risks (Brexit, trade war), than by any fundamental changes in the eurozone’s economic recovery. Indeed, the ECB expects to see growth in the region of 1.5% from the third quarter of 2019 onwards.
Weakness across manufacturing sectors is nonetheless dragging on eurozone growth surveys. The composite PMI fell from 51.9 to 51.3, still above its January low, but the manufacturing sector slumped further to 47.6% and the accompanying comments drew attention to deep uncertainty, due in particular to Brexit. Economic data were more robust, with eurozone retail sales jumping 1.3% in January and industrial output rising 1.4%, despite German output detracting from the overall rise due to weakness in its automotive industry. That said, data for February signal a recovery in German car manufacturing.
THE FED ON HOLD
At the meeting on March 20th, the Federal Reserve unsurprisingly left its benchmark rate unchanged at 2.25–2.50%. The key focus was on the quarterly update to the FOMC’s interest rate forecast, which has been lowered to zero from December’s forecast of two hikes in 2019. The FOMC still expects rates to rise by 25 bps in 2020, and not at all in 2021. In addition, the Fed stated that from May, it would be slowing its balance sheet shrinkage process and closing it in October 2019.
Taken altogether, these announcements confirm that the Fed’s tightening policy is officially on hold, and echo Chairman Powell’s indications from January, following the sharp market correction. Jerome Powell is maintaining his relatively optimistic message on US growth despite downwardly revising his forecast slightly by 0.2 percentage points to 2.1% for 2019. However, he sees developments on the domestic and international horizon as reasons not to rush into any changes to current monetary policy.
Some of this year’s economic releases have been surprisingly disappointing, not least February’s job creations that came in at only 20,000. However, January’s 300,000 job creations number was very high and polar weather conditions across the US Midwest probably played a role in depressing February’s data. The other employment indicators from the jobs report were healthy, including a steady number of average hours worked and a pick-up in the pace of hourly wages to +3.4% year-on-year. All told, the real picture is probably less sobering than this steep plunge in job creations would lead us to believe. Although December 2018 retail sales were discouraging, posting record falls, they too turned around in January.
While the Fed Chairman appeared optimistic on growth, his comments on inflation were notably more circumspect. His press conference statements indicated that he does not think that the Fed has convincingly fulfilled its symmetric 2% inflation mandate, leading observers to understand that the central bank could tolerate an overshoot of the target for an extended period. The Fed’s preferred inflation measure had been clearly rising for a period of 18 months before it recently turned back down to settle at +1.9% year-on-year in December.
GOVERNMENT STRENGTHENS SUPPORT FOR THE ECONOMY
During his opening address at the National People’s Congress, Chinese Premier Li Keqiang announced an unsurprising 2019 growth target of 6–6.5%, which contrasts with last year’s fixed target of ‘approximately’ 6.5% and actual growth of +6.6%. In fact, the target probably lies in the upper, rather than the lower, end of the stated range. A 6.0% outcome would complicate the government’s goal of doubling GDP by 2020 and require growth of approximately 6.2% in 2019 and 2020.
To reach the target, Premier Li Keqiang also announced more fiscal policy loosening with, in particular, a cut in VAT of 3% to the 16% rate and 1% to the 10% rate, and lower social security contributions. The government indicated that the 2019 cuts equate to approximately 2% of GDP (RMB 2,000 billion). Analysts estimate that the growth impact of the cuts stands in the region of 0.5% of GDP, which should cushion any negative impact from fears over international trade flows.
Although China’s exports fell sharply in February (-20.7% year-on-year), foreign trade data is notoriously volatile for this period due to Chinese New Year never falling on a fixed date, and the correction needs putting into perspective. In addition, the base effect is very unfavourable, as exports in February 2018 rose 43.6%! US-China trade negotiations continue to progress, and the latest developments have been positive. The US administration has agreed to extend the trade truce for the time being, raising expectations for an agreement.
Other data have sent mixed signals about the Chinese economy in the first quarter. The first two months of 2019 proved slow for industrial output (+5.7% January; +5.3% February), while investment expenditure rebounded (+5.9% January; +6.1% February) and retail sales stabilised. After a sharp rebound in January, February’s credit expansion turned back down. The Caixin composite PMI also fell for the second straight month, moving from 50.9 to 50.7, although this slight dip masks a rise in the new orders component that suggests a recovery in output.
The opinion expressed above is dated March 25th, 2019, and liable to change.
This document is not pre-contractual or contractual in nature. It is provided for information purposes. The analyses and descriptions contained in this document shall not be interpreted as being advice or recommendations on the part of Lazard Frères Gestion SAS. This document does not constitute an offer or invitation to purchase or sell, nor an encouragement to invest. This document is the intellectual property of Lazard Frères Gestion SAS.