BoE Cuts Rates, Adds to QE

The UK's Monetary Policy Committee today announced their first interest rate cut in seven years, lowering the benchmark rate to a record low of 0.25%.  The rate cut came as no surprise to markets worldwide, and the MPC vote was 9-0 in favor of the cuts.  What did surprise some, however, was a £170 Billion stimulus that will be introduced via the purchase of Gilts (UK government backed bonds similar to US Treasury Bonds), the purchase of corporate bonds, and a new bank lending program.  That portion of the stimulus package was not expected to coincide with the interest rate cuts.

The FTSE responded positively to the news, finishing the day up 1.56% although the Pound dropped 1.5% versus the US Dollar and 1.3% versus the Euro.  US markets responded with a yawn, finishing the day flat.  The US 10-Year Treasury Yield, however, dropped 2.58% to 1.51.

BoE Governor Mark Carney sounded a pessimistic note in his presentation, stating, “We took these steps because the economic outlook has changed markedly.  Indicators have all fallen sharply, in most cases to levels last seen in the financial crisis, and in some cases to all-time lows."  That's a bit troubling, given the lengthy duration anticipated for the actual Brexit events to unfold.  With the benchmark rate now down to an extreme low, there is very little additional room for the BoE to maneuver should the British economy slow further.

Surprisingly, the MPC signaled the potential for a further rate cut, although Carney assured reporters that the central bank had no intention of bringing rates into negative territory.  That they would consider - and even signal - that rates could drop to near zero, however, indicates the level of concern the committee has over the economic prospects during the Brexit transition.

The fallout from the Brexit vote has manifested more slowly than critics had forecast, but - at least in the UK - it is starting to be felt.  Consumer Confidence is dropping dramatically, and the industrial outlook is starting to decline as well.  The forecast for the UK GDP is now down to 0.8% for 2017, and the Central Bank foresees a strong decline in corporate investment and in the housing markets.  The Pound's weakness is certainly hurting UK imports, and that is having a marked effect on growth potential over the next 18 months.  That import price pressure is expected to have an impact on inflation in 2017, with the central bank forecasting inflation to hit their 2% target in the fourth quarter of 2017 and exceed it throughout 2018.

What all this signals is a period of weakness, uncertainty, and potential market instability in the UK that will likely last through 2018.  With the ECB taking a bit of a "wait and see" attitude mingled with a healthy dose of skepticism a couple of weeks ago, the likelihood of continental fallout is extremely high.  US 10-Year Treasury yields have declined steadily since December, 2015, and are now sitting at the lows last seen in August, 2012.  That represents a significant flight to safety, and with US equities sitting near all-time highs, it's reasonable to conclude that the heavy demand on US treasury bonds is coming from overseas.

There is a limit to how long the US can remain immune to economic weakness in the UK and the EU.  The strong US dollar is having a severe impact on US exports, and that, in turn has a serious impact on US companies that are heavily exposed to Europe.  This is evident in the behavior of the S&P 500 where demand has fallen off over the past few weeks, and the market has gone essentially flat since it reached a record high in mid-July.  With GDP growth down dramatically in Europe, the UK, and the US, prospects for a global recession are mounting as we transition from a tumultuous US presidential election to the uncertainty of a prolonged Brexit negotiation and execution.

Earnings season in the US is almost over, and there is not another FOMC announcement before September 21.  So now we turn our attention to tomorrow's jobs report.  The pattern in the market right now is not encouraging, so the key economic reports over the next few business days may well set the tone for the remainder of August. 

Happy Trading

ECB Holds Rates Steady; Leaves Door Open for Stimulus Later This Year

The European Central Bank announced this morning that they were holding rates steady, meeting market and analyst expectations for their July meeting.  The main refinancing rate remains at 0%, the deposit rate is steady at minus 0.4%, the marginal lending facility rate at 0.25% and the ECB held their Quantitative Easing position at a monthly €80 Billion.  None of this came as a surprise to world markets which have thus far stabilized since the surprising Brexit vote in June.

Caution was the order of the day as the Central Bank adopted a "wait and see" attitude, postponing any decisions until their September 8th meeting.  There's growing speculation that an increase in Quantitative Easing could be announced then, however in his post-announcement speech Mario Draghi stated, "We confirm that the monthly asset purchases of 80 billion euros are intended to run until the end of March 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim." 

Haven't we heard that before?  It sounds very similar to the tune sung by the US Federal Open Markets Committee throughout the final year of QE3 here in the States. Essentially, yes they have an end-date, yes there's a fixed amount planned into the process, but oh by the way, that end date will ultimately be data dependent based upon the prospects for normalized inflation, defined both in Europe and in the US as 2%.  With the current rate of inflation in the Eurozone sitting at 0.1% following a year of deflation, that March 2017 target looks like a pipe-dream.

Draghi briefly addressed Brexit in his speech, saying "All we can say is that it is a risk that has materialized and it is a downside risk." This, too, is inline with the wait-and-see attitude that permeated the speech, and it's consistent with the approach being taken in the UK and US.  With the pending start of UK separation delayed until some time in 2017, fears of immediate turmoil have abated and none of the Central Banks are eager to take any action that might upset the tentative stability world economies have experienced over the last 3 weeks.  The word from all of them is that additional data is needed before any action (if action is warranted) can be considered.

With no major policy changes coming out of the ECB this month, the focus will now shift to Janet Yellen and the FOMC announcement on July 27th.  As with the ECB, no policy changes are anticipated in the US either, although the robust reaction of the stock market this month, combined with good corporate earnings and relatively good economic data have analysts anticipating a softening of the extreme dovish tone in their guidance on interest rates.  At this point, the market has factored in a 19.5% probability of a rate hike on September 21, up from 12% a week ago.  A December 14th rate hike probability has jumped to 40%, up from 30% last week.  It will be interesting to check these numbers following Yellen's announcement next week.

For now, it looks like the remainder of the summer will be uneventful from a Central Bank perspective.  That leaves only earnings and economic data to drive the markets, and both have been trending positive for much of July.

Happy Trading.

Bank of England Holds Rates Steady; Signals August Stimulus

Despite market estimates of an 80% chance for a rate cut today, the Bank of England held rates steady at 0.5%.  With new Prime Minister Theresa May signaling a slow and cautious path towards Brexit and also signaling an invocation of Article 50 no earlier than 2017, the central bank's delay in lowering interest rates makes sense. 

Only 2 1/2 weeks have passed since the Brexit vote, and that is an insufficient amount of time to gather enough data to make an informed projection on the economic climate for the next six to twelve months.  The MPC (Monetary Policy Committee) next meets on August 4th, giving them additional time to gauge the reaction and potential impact.

Additionally, despite the immediate reaction worldwide on June 24 and 27, markets in the UK and around the world have since stabilized and, in fact, rebounded significantly.  In the Forex market, the British Pound did indeed take a significant hit against both the Euro and the US Dollar, however the currencies have since stabilized albeit at the lower levels experienced immediately following the vote.

Given the slight trade imbalance the UK currently experiences, that overall drop in the Pound is actually very good for their exports.  It provides an immediate boost to UK-based corporations and, in that context, is a nice stimulus without the Central Bank taking any actions at all.  Coupled with that, initial fears that companies would seek to relocate out of the UK have since abated.  To that point, JP Morgan Chase CEO Jamie Dimon specified in today's earnings call that he had no intention of leaving the UK despite rumors to that effect on June 24th.  Following the initial shock of the vote, we now see other companies taking a step away from the ledge, realizing that the new dynamic offers tremendous opportunity, not peril.

What the Bank of England has done by standing pat is afforded themselves some options later in the year should the British economy weaken to the point where a stimulus in the form of a rate cut becomes necessary.  Lowering that key rate today would have left the Central Bank with no room left to move as the UK approaches what will certainly be a period of uncertainty after they invoke Article 50.  Remember, the BoE already provided a significant stimulus on July 5th when they eased capital requirements for commercial banks, effectively providing a £150 Billion short-term stimulus.

The change in capital requirements on 5 July was seen as a direct attempt to prevent a repeat of the 2008 crisis in which banks ceased lending.  Whether or not that move is sufficient only time will tell, however as of today the signal is that the MPC is thus far satisfied with the short-term results.

Today's decision underscores a strengthening in the overall financial stability of the UK and stands in stark contrast to some dire warnings issued by Governor of the Bank of England Mark Carney just a week ago: “The number of vulnerable households could increase due to a tougher economic outlook and a potential tightening of credit conditions. In particular there is growing evidence that uncertainty about the referendum has delayed major economic decisions, such as business investment, construction and housing market activity.  The UK has entered a period of uncertainty and significant economic adjustment."  The wording is particularly harsh coming from such a prominent member.

There's no word as to what measures the Committee are considering in August, however according to officials there was significant discussion of it in today's meeting: “Most members of the committee expect monetary policy to be loosened in August.  The committee discussed various easing options and combinations thereof. The exact extent of any additional stimulus measures will be based on the committee’s updated forecast, and their composition will take account of any interactions with the financial system.”

The August 4th meeting comes only a week after the US Federal Opens Markets Committee (FOMC) meets.  Fed Chair Janet Yellen typically addresses the economic environment in Europe and the UK in her post-meeting announcement, so it will be worth listening to that release for clues as to any action the Bank of England may feel necessary.  Given the interrelationships between the various central banks and the global impact each of their decisions have, it would be a mistake to focus only on the MPC for guidance as to what the future economic environment may entail.

Also of interest is the next European Central Bank (ECB) meeting, scheduled for 21 July.  Again, listening to Mario Draghi's perspective will add further insight.  It's likely that, between the ECB and FOMC, we should have a fair idea of the direction the Bank of England may take on August 4th.

Happy Trading.

Greek Stalemate Continues

Despite the optimism expressed late last week, talks between Greece and the other EU Finance Ministers broke off after only four hours today.  The talks had been expected to run well into the evening, but were deemed pointless after Greece flatly rejected the EU proposal of a six-month extension to the bailout.  The effect on the markets tomorrow is uncertain, and we'll be watching the Asian markets overnight for some indication as to how US equities and bond markets will react.  (US markets were closed today for Washington's Birthday, known popularly as Presidents' Day.)

The next major milestone in the sage will come on Wednesday.  That's when the European Central Bank (ECB) will decide whether or not to continue their emergency lending program to Greek banks.  Without that program, Greek banks have less than 14-weeks of solvency remaining.  They are hemorrhaging deposits at the rate of over €2 Billion  ($2.27 Billion) per week. In just three months, the banks will not have the collateral needed to obtain loans from the Central Bank, although the real crunch will come in late March when Greece faces some heavy loan repayment requirements.

Part of the problem appears to be a question of semantics.  Greece is willing to accept "six months of credit" however they will not accept a six-month extension of the bailout.  Economics Commissioner Pierre Moscovici expressed his frustrations, saying "We need more logic and less ideology."  The EU officials were dismayed last week by what they portrayed as a total lack of preparation on the part of the Greek finance ministers, and they question whether or not the young government understands the seriousness of the situation.  For now, the EU feeling is that Greece is putting political concerns ahead of the dire economic needs facing the nation.

The ball appears to be in Greece's court since several ministers were quoted as saying that further talks would require Greece to request a bailout.  A separate but equally contentious issue remains over the austerity programs that were tied to the original bailout.  Greece is on record as proposing a halt to those austerity programs as part of any new agreement, however the EU - especially Germany, their largest creditor - wants none of that.  According to German Finance Minister Wolfgang Schaeuble, Greece has "lived beyond its means" for a long time.  Neither Germany nor the rest of the EU are willing to continue to provide bailout funds without proof that Greece has learned to manage its debt.

Polls in Greece appear to put some pressure on the young leftist government to reach a compromise.  68% of Greeks seek a fair compromise, while only 30% advocate standing firm against the EU.  An astonishing 81% want Greece to stay on the Euro.

There is growing fear that the failure of the debt talks will lead to the imposition of strict capital controls.  There's precedent for that.  In 2013, Cyprus was forced to close the banks for two weeks while capital controls could be introduced.  With the Greek banks closed next Monday for the first day of Lent in the Orthodox Church, there's fear that the ECB could impose such restrictions as early as next week.

For now, it's back to the game of brinkmanship.  With an inverted yield curve and the yield on short-term Greek bonds now in the upper teens, time is not on Greece's side.  They are facing the total collapse of their banking system in a matter of weeks, and the only bargaining chip left in their arsenal is an agreement to remain in the Eurozone.  The further this goes, however, the less valuable that chip will become.  With the Greek banks losing close to €300 Million per day, the prospect of terms favorable to Greece are diminishing by the hour.  

France's Hollande Claims QE Announcement on Thursday

In a bit of political daring-do, French President François Hollande stated today that the European Central Bank (ECB) will announce a Quantitative Easing (QE) policy when it meets on Thursday.  Given the ECB's strong resistance to political pressure, it's surprising to hear that Hollande is predicting the outcome of Thursday's meeting.  Speaking to business leaders at the Élysée Palace, Hollande said, "On Thursday, the ECB will take the decision to buy sovereign debt, which will provide significant liquidity to the European economy and create a movement that is favorable to growth."  The Stoxx Europe 600 soared to a 7-year high on the prospect.

This is a bit of a dangerous tightrope being walked by President Hollande, and given the number of false starts in the ECB QE saga, he is apparently doing it without a net.  His comments came as a surprise to analysts despite widespread belief that the ECB will indeed take action this week.  That action is already built into the bond market, in fact, which means a failure to act will result in some wild price action, especially now that Hollande has upped the ante by upstaging Draghi.

The question here, though, is what it means for the US markets.  When Japan introduced their flavor of QE, that increased liquidity flowed right out of Japan and into the much stronger US and European markets.  Similarly, when the US introduced QE, that money flowed out of the States and into emerging markets that were viewed as the stronger growth play at the time.  It's reasonable, therefore, to assume that the US stocks and bonds markets will benefit from that increase in European liquidity. 

There's no question that US bonds are a more attractive, more stable, and safer investment in the fixed-income space.  The equity side, though, will benefit from the perceived strength of the US economy, rising in stark contrast to a European economy in a deflationary spiral on the brink of recession.  The US Dollar will strengthen even further as a result of this move, however, and that will place added pressure on US equities that have significant exposure to Europe - meaning a large portion of the S&P 500.  Short term, of course, there's likely to be excitement and buying pressure in US equities, even if that rise is short term over-exuberance.

At the very least, thanks to Hollande's comments, if Draghi's announcement on Thursday wasn't already the most anticipated economic release of the week, it has certainly vaulted onto that stage now.  I suspect the news will at least take some of the downward pressure coming out of Europe off the table, at least through the early part of the week.  Whether or not the "buy on rumor; sell on news" adage manifests, though, will be one to watch.  After all the anticipation, it's possible that Draghi's press statements on Thursday will be anti-climatic.  The market expects the QE package to include €500 billion to €600 billion of sovereign bonds, and another €400 billion in private assets.  Failure to deliver on that expectation will almost certainly be punished in the US, UK, and European markets.

The ECB will announce their interest rates decision Thursday at 12:45 GMT (7:45 EST) and the much anticipated ECB Monetary Policy Statement and Press Conference follows at 13:30 GMT (8:30 EST).  With the US markets opening an hour after that press conference starts, expect much of the morning's trading to be dominated by reaction to Draghi's comments.