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Is the central bank put back on? If so, why are investors the most bearish since 2008?

21 June 2019

Two weeks ago, we commented on the notable reversal of the Federal Reserve's (Fed) attitude towards its monetary policy. The remark “we will act as appropriate to sustain the expansion” within Powell’s most recent speech has garnered much attention. This language marks a change from the Fed’s previous stance, that it would be “patient” in determining changes to its interest rate policy. Whilst the Fed held interest rates steady, it shifted towards a more dovish stance and even pointed to possible interest rate cuts in the future, citing rising “uncertainties” for the economic outlook. With trade tensions rising and various economic data points pointing towards a slowdown, Powell and other members of the Federal Open Market Committee have begun to seriously consider interest rate cuts. The more dovish comments appear to have been positively received by markets and so the Fed put appears to endure. Thus, it appears that we are entering an era of the "Powell put", with markets shaped by the conjecture that the Fed will do whatever is needed to avoid a downturn.

We have previously highlighted that the comments from the European Central Bank (ECB) during its press conference, with respect to its forward guidance, were relatively disappointing. Until not so long-ago, the ECB was thinking more in terms of rate rises, as opposed to rate cuts. It has since joined the Fed in effectively reassuring markets it will act as appropriate to support markets. Concerns regarding falling inflation expectations appear to have led to the shift in tone. During the ECB's annual symposium on Tuesday, Mario Draghi indicated that should inflation continue to languish below the 2 per cent inflation target, they are prepared to trim rates. He continued to hint that it could even restart its quantitative easing programme. Faced with “pervasive uncertainty” and persistently low inflation, the ECB stands ready to act again today, with rate cuts and new asset purchases both on the table.

With central banks having sharply reversed course and preparing to intervene, they have re-established their put. In theory, this should be constructive for risk assets, and should provide some comfort to investors and soften any potential blows from a trade fall-out. However, the Bank of America Merrill Lynch June Fund Manager survey was the "most bearish survey for investor confidence since the Global Financial Crisis". Pessimism is being driven over concerns of the trade war and the likelihood of a recession. Despite the actions of central banks, investors remain apprehensive over the trade war, its disruptive impact on supply chains and capital expenditure, and its ultimate ramifications for global growth. Investors and businesses do not want to be caught on the back foot. US industrial output has weakened in recent months and last month the Purchasing Managers’ Index hit its lowest reading for almost 10 years. Apple recently indicated it is considering shifting 15% to 30% of its production out of China. In a letter that was made public on Thursday, Apple even urged the Trump administration not to proceed with further tariffs of as much as 25% on numerous other products imported from China, saying it would reduce their contribution to the US economy. It is perfectly within China's arsenal of retaliatory tactics to simply withhold exports to the US, not necessarily limited to its exports of rare earth materials.

Other data points are not so easy to resolve with rate cuts. Survey data highlights that American consumers feel more confident about the economy than at any point since 2000, and household spending remains robust, with unemployment reaching 50-year lows. US retail sales have been strong and inflation remains below target. Central banks usually prepare to intervene only once they see strong signs of a sharp economic slowdown in response to weak economic data, rather than what appears to be preparation in advance. In the past central banks have tended to come out with a more aggressive policy action when markets have disappointed. But with markets at all-time highs, arguably, central banks appear to be rushing-in to support economies, pre-empting escalation of trade tensions. Should a trade-deal be reached, we expect rates not to be cut given the resolution itself would be enough to support markets.

The trade outlook has brightened slightly since the beginning of the month, and since the data was collected for the Fund Manager Survey. With Trump having cemented plans to meet Xi Jinping at the G-20 summit in Japan next week, this represents a step in the right direction. However, unless the meeting marks the beginning of a genuine and lasting de-escalation of global trade-wars, the Fed and the ECB will most likely have to step up their stimulus. Softening without acute recessionary fears indicates that the central bank put is back on, meaning they are prepared to intervene should markets fall to sustain an expansion. For both central banks it will be of paramount importance to make it clear to the market that they will react to the signal, and not the noise.

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