Central bank policymakers have been holding markets in the palm of their hands since the 2008 Global Financial Crisis. While this may have abated temporarily as markets boomed ahead between 2016 and 2018, with the cycle advancing and markets growing more worried about the next downturn, central bank action is in the spotlight again.

The most accommodative of them all
The European Central Bank (ECB) looks set to take the crown as the most accommodative central bank in September, as it embarks on another round of monetary stimulus. Indeed, ECB President Mario Draghi is likely to announce an interest rate cut from the current -0.4% of its main refinancing rate, a possible ”tiering”1 for bank deposits in an effort to protect the sector, and even renewed asset purchases. This is in addition to the latest targeted longer-term refinancing operations (TLTRO III) to inject liquidity into banks, set for September as well. As such, in his last months as ECB chief, Draghi will leave his successor Christine Lagarde with a clear path of support.

Central Bank Rates
Central Bank Rates
Source: Bloomberg, Natixis Investment Managers, Jan. 2009 – July 2019 (monthly)

For its part, while the US Federal Reserve (Fed) appears to have more room to ease, the US economy does not require the same amount of support. Fed Chairman Jerome Powell set a relatively dovish tone during his recent speech in Jackson Hole, Wyoming, reassuring markets about the Fed’s readiness to act if needed, but perhaps trying to prepare markets for less easing than priced in, given a still solid US economy. Powell is navigating a difficult path, trying to support sentiment while avoiding fueling asset bubbles and the wrath of President Trump – who continues to pressure the Fed about more aggressive cuts.

In our view, a September cut is a given – and already firmly priced into markets – but expectation for another three cuts after this seems excessive. One or two more cuts in 2019 if trade tensions persist and pressure on Mr. Powell remains are likely, but the US economy does not currently need much more support.

Is this really needed?
US growth is slowing, but looks to be stabilizing around 2%. Indeed, the US consumer remains healthy as seen in strong retail sales, the labor market – despite little wage pressure – remains tight, and housing is benefiting from lower rates. In addition, core inflation has been rising in recent months, reaching 2.2% in July.

However, long-term expectations for inflation remain low and have not risen, pulled down by growth concerns due to the US-China trade dispute. The Fed looks at current core inflation as well as expectations for the future, giving the Committee ammunition to justify more support. Moreover, ongoing global trade tensions are weighing not only on the global growth environment but also on the US outlook, in terms of exports and in terms of business sentiment and investment. As such, while one could argue that rate cuts are not currently necessary, a few insurance cuts can be justified.

Europe, on the other hand, remains stuck in the middle of a trade spat it cannot influence, while suffering the growth consequences. With more export-oriented economies, more dependent on Chinese growth and demand, the Eurozone economy is struggling. Indeed, while the region showed some tentative signs of stabilization, it is flirting with recession yet again, and certainly needs further support.

The euro area grew around 1.1% in the second quarter, but Germany and Italy both contracted, and are likely to show a similar pattern during Q3. Political tensions between the EU and Italy, and of course the ongoing Brexit saga, contribute to uncertainty and downside risks. In addition, inflation remains missing in action, stuck around 1%, justifying additional measures by the ECB. And despite the ECB’s best efforts, the euro has not weakened much, which would be a welcome boost to assets and to inflation.

The limits of monetary policy
The dovish tone is set. The question we now face is whether all these actions will work, or if we have reached the limits of monetary policy. Indeed, we have seen a decade of ultra-accommodative policies, with mixed results.

Central Bank Balance Sheets
Central Bank Balance Sheets
Source: Bloomberg, Natixis Investment Managers, Sept. 30, 1999 – Aug. 10, 2019

In Europe, we do not believe it will succeed in lifting the Old Continent and its structural struggles. Mr. Draghi has been both aggressive and creative with his policies, and remains convinced we have not reached the end of monetary policy efficacy, but the scope for additional easing is limited and the effects have been underwhelming. Mr. Draghi is aware of this, and has often called for fiscal measures as a complement to monetary ones. With the arrival of Mrs. Lagarde at the ECB’s helm in November, pressure on European institutions is set to increase, but in any case it will take time.

Yes, talk of a German fiscal stimulus package has begun, but the German Constitution does not make this a straightforward matter, requiring “special circumstances” or an economic “emergency.” It is nonetheless still a welcome development. It might also be the catalyst needed to halt the fall in global yields, as Bunds have been dragging the rest of the world with them, into ever more negative territory.

In the US, the Fed has been more successful in lifting growth, and especially markets. Indeed, we believe that one risk is that the Fed becomes too market-dependent instead of data-dependent – following market expectations rather than leading them. And ongoing pressure from Mr. Trump is not helping. From his perspective, the Fed is a safety net for his trade wars, and a tool for a weaker USD. However, the flight to safety precipitated by trade tensions is actually supporting USD instead of weakening it, despite an accommodative Fed.

Global synchronized easing
Elsewhere, the Bank of Japan (BoJ) remains in perpetual accommodative mode, with limited room to increase its stimulus scope, with debatable success. Growth remains anemic, but the BoJ has managed to lift the economy out of deflation, though it remains far from its 2% target.

China might be the partnership model the West should aspire to, as the People’s Bank of China (PBoC) is supported by targeted fiscal measures. This synchronized approach helped lift China out of the global financial crisis, and out of the 2015 slump. It also helped with painful economic rebalancing, and to manage the gradual structural slowdown.

We are also seeing a slew of emerging and developed central banks taking advantage of the Fed’s cuts to cut interest rates themselves, while avoiding too much currency devaluation.

Conclusion
We have yet to see the end of monetary stimulus, as central banks work to extend the cycle and postpone the next downturn with never-ending accommodative policies. However, the longer these measures last, the less impact they seem to have, and while we do not see an imminent recession, we believe that the ECB will not manage to jump-start the European economy on its own.

Central Bank Balance Sheets

1 The term “tiering” refers to central banks reducing the amount of excess liquidity subject to negative interest rates, without moving the deposit rate.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed are as of August 26, 2019 and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.

All investing involves risk, including the risk of loss. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

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