by Brad Tank, CIO, Fixed income, Neuberger Berman
The ECB’s accommodative stance removes one more obstacle from a global soft landing.
As my colleagues and I prepare our latest quarterly Fixed Income Investment Outlook, it is worth recalling that our last one, which came off the press on December 19 and was battered by the winter storm in markets, made a bold call for a “soft landing” for the economy.
Three months and 150 basis points of high yield spread tightening later, those wintry markets have calmed down and come around to our way of thinking. Still, our thesis has yet to play out in full. It depended, firstly, on central banks recognizing the need for a more accommodative stance, and, secondly, on a stabilization and recovery in economic data out of China and Europe. How far have we come to clearing those hurdles?
Momentum
As I wrote back in January, we got good reassurance from Jerome Powell then that “the Federal Reserve is not the threat.” The messaging around holding rates steady over the coming months was much clearer than it had been in December, and Powell even departed from his strict data-dependency line to acknowledge that the FOMC was sensitive to what the market was telling it.
That gave the New Year bounce some strong momentum.
Just over a week ago, the European Central Bank got its opportunity to reinforce that message.
On the positive side, the central bank surprised markets with an earlier-than-expected announcement of new Targeted Long-Term Refinancing Operations (TLTRO 3) and an extension to its forward guidance on the deposit rate, which remains negative. The TLTRO 3 loans would be offered quarterly, at two years’ maturity, with a cap on how much any one bank can borrow.
Winter Chill
Thereafter, the message darkened as Mario Draghi presented the central bank’s revised growth and inflation forecasts for the euro zone. This year’s GDP growth rate was cut from 1.7% to 1.1%, and 2019 inflation was revised down from 1.6% to 1.2%—with no sign of the “near 2%” target through 2020 and 2021.
The ECB has been much more optimistic than the markets for some time, and while those revisions could be viewed as simply closing that gap, they still came as a bit of a shock. Additionally, Draghi acknowledged that the slowdown probably isn’t temporary; he repeated his consistent message that euro zone fiscal policy could be more accommodating, and that structural reforms need to be stepped up substantially.
European bank stocks got a late blast of the winter chill, losing more than 5% over the course of two trading sessions. The euro weakened and Bund yields plummeted, leaving the German yield curve at its flattest for nearly three years and negative out to more than nine years.
Accommodative
With a week to digest the news, however, investors appear to have acknowledged that, on balance, TLTRO 3 adds to the accommodative environment prepared by the Fed in January. Both U.S. and European equity indices recovered their post-ECB losses, with banks pulling back at least some ground. Germany’s DAX Index is up 1.5% as I write on Friday, and Italian government bonds have tightened by five basis points against German Bunds.
On the underlying economic performance, there is still work to do. While U.S. data has stabilized at reasonable levels (acknowledging some noise from bad weather and the government shutdown), most numbers out of China and Europe continue to get worse. We need to see China’s stimulus efforts gaining more traction over the coming months to underpin a recovery in the global-growth-oriented economies of Europe, Japan and the emerging world.
We believe that is what we will get. In the meantime, I think we can chalk up this quarter’s moves from the Fed and the ECB as a clearance of the first hurdle for our soft-landing thesis.
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