Post Fed Turbulence continues pre ECB

Summary

Surprisingly weak Chinese activity data put shares under further pressure after the market’s ambivalent reaction to a less cautious Fed.

Too hot and too cold

The Fed hike that seemed perfectly priced in advance, turned out to be too hot for Asian shares and undercooked for the dollar. Weak prints in Thursday’s Chinese activity data prompted the People’s Bank of China to unexpectedly skip the tightening normally seen after a Federal Reserve rate rise. Turbulence that upended Asia-Pacific indices now ripples through European stocks and U.S. futures. This confluence of events risks jeopardising the best efforts of Fed chair Jerome Powell to engineer a smooth transition to a faster tightening, without ‘tantrums’. Whilst the ECB is likely tread even more carefully later, it can scarcely avoid flagging the QE exit after trailing the move so clearly earlier in the month. A retreat to safety, with European markets having joined the sea of red, could remain the order of the day till ECB news and beyond.

Don’t forget EM

Risk aversion after surprising economic readings in China partly hinges on the potential for further emerging market asset discomfort – not directly addressed by the Fed despite recent turmoil in Argentina, Turkey, Brazil. EM dislocations and curve flattening concerns are likely to continue haunting markets with Fed asset reduction scheduled to reach $40bn a month in July from $30bn now and $50bn/month in Q4. At the same time, as the U.S. economic pace approaches a peak, the Fed’s hand is being forced, helping account for dual-facing FOMC forecasts—unchanged Median Long-Run growth, unemployment and inflation forecasts that were tweaked higher in 2018. Against this backdrop the ECB’s attempts to get policy guidance ahead of the curve may prove insufficient

How determined is the ECB?

European monetary policymakers have put the market on notice that they would debate the end of asset purchases on Thursday. The key question for investors is how strong resolve to do so will be as growth slows and unforeseen economic hazards emerge. The latter include tariffs and a newly conflicted Eurozone member, Italy. There’s logic in the view the ECB should hasten the removal of stimulus, if less conformist fiscal trends take root. But that logic will butt up against technical and political facts beyond Italy, particularly if slower growth persists. As oil prices, the key input to recently revived inflation, ease, pressure on the ECB to act may fall too. The euro was up a solid 30 pips as the dollar’s Fed-fuelled advance went off the rails on Thursday, but the single currency remains pretty much 5% lower from mid-February’s tops. That reduces ECB urgency further, particularly after the Fed dropped a decade of caution by rescinding the pledge to keep rates simulative for “a long time”. A new formulation of how ECB rates tie in with QE is more likely to be presented on Thursday. Guidance on a hike is widely expected to come slightly forward from “well past” the end of QE, to shortly after a demonstrably sustained rise in inflation. With markets pricing just 10 basis points of tightening by 2019, policymakers have even more preparatory work to do.

Post-ECB reversion potential

Either way, ECB news could stem some of the odd shapes markets are throwing in an unusually multifaceted week. U.S Treasurys could lead any reversion with the 10-year yield coming up to 60 basis points off Wednesday’s high despite a hawkishly optimistic Fed. The rate was stabilising at 2.9516%, last look, Monday’s low. In turn, the euro will need solid reasons to surpass and sustain above the $1.1840 reversal high ahead, its peak after Italy turmoil calmed. Doing so could require a proven return to growth as well as a more ruthless ECB than expected. Sterling’s follow-through on Wednesday’s firm close, backed by a retail surge, was backing off a bit at last check, well below $1.3455-$1.3482, the site of aggressive reversals last month and earlier this month. This after PM May’s government defeated final challenges to the Brexit bill. An unexpected widening of rifts in the opposition party, with a shadow cabinet resignation among six senior exits, threatens to unbalance political conditions that have helped soften the government’s Brexit plans.

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