ECB To Ease Further? Fed To Follow?

There has been an interesting shift in sentiment this week as we’ve see the unfolding of important global market events. As ever, the fascinating crowd behaviour present in Forex markets which continues to see the birth and death of consensus calls is potentially watching the last days of another “sure thing”: A 2015 US lift-off.

From the early part of this year where markets seems convinced of an imminent Fed rate hike, with many calling for a June lift off point as a strong possibility, we’ve now seen these lift-off expectations pushed out – first to September and then December and now into 2016 with markets pricing a 49% chance of a December lift-off and 54% of a January tightening.

So what has caused this shift in sentiment? As ever the changing global picture continues to disrupt outlooks, forecasts and plans.
The Greek crisis that plagued the markets during the early summer months has now been upstaged by a sharp slowdown in China and the devaluation of the Yuan and subsequent periods of acute equity market weakness as we saw on Monday 24th August
The sentiment ruling the first part of the year was that the US economy was back on track and that the global picture was stable enough to allow the Fed to lift rates without causing dangerous volatility.

Well the global picture has deteriorated and the dangerous volatility is already here so it’s unlikely that the Fed would look to add to this situation with a rate hike. In comments made today, the Fed’s Dudley said that “international developments” pose a risk to the US economy and that the case for a September rate hike is “less compelling” than it was a few weeks ago. Dudley said that whilst he “really hopes” to raise rates this year, incoming data needs to be accounted for.

It will be interesting to monitor comments coming out of the US Jackson Hole summit over the next week as policy makers meet for their annual discussions. Notably however, the Fed’s Yellen will be absent from this meeting with speculation suggesting her avoidance of the difficult questions that would be asked of her.

Clearly there is broad risk to the notion of a US rate rise this year and although Dudley confirmed that he is “a long way from talking about new quantitative easing”, with the global picture so fraught currently, it’s not unreasonable to expect that a further deterioration in stability could bring us to that point.

Bridgewater founder Ray Dalio thinks we are already there and that the next move the Fed make will be to ease, not to tighten as the risk of deflationary contraction increase.
The inflation picture remains troublesome in the US as in other parts of the world.

Commodity markets and oil prices which weakened at the start of the year were expected to pick up heading into the year end, however commodity markets have continued to decline as to have oil prices leaving price pressures subdued and weighing on inflation forecasts.
With global markets so rocked by volatility, central banks are in defensive mode looking to ensure stability and ease concerns not exacerbate them further. From wanting to see the Fed raise rates to further fuel a recovery, markets are now concerned about how the Fed will be able to support markets should an economic slump materialise out of this China slow-down.

With this in mind, it’s prudent to look at the policy bias of another central bank.

The ECB’s QE program seemed to have begun with a flying start. Economic indicators were picking up and crucially inflation seemed to be bottoming with the ECB sounding more upbeat about inflation expectations and there was talk that perhaps we would see ECB QE ended before the declared September 2016 end point. Fast forward a few months and the ECB who sounded upbeat about the inflation outlook earlier in the year have now changed tone with comments today by the ECB’s chief economist stating that “downward risk has increased” in terms of achieving a sustained path of inflation.

Against a backdrop of new 2015 highs in EURUSD and with the absence of an imminent US rate hike there is increasingly a view point that the ECB are going to be forced to introduce some further measures which no doubt will begin with verbal intervention but likley will see some definitive action quite soon. With ECB’s Praet reiterating “There should be no ambiguity on the willingness and ability of the governing council to act if needed.”

It may well be that we don’t in-fact get any further ECB easing, and we still see a Fed lift-off dated 2015, but what is of interest is just how quickly the shift in sentiment has occurred to bring us to a place where markets are contemplating such starkly different future outcomes.

The events in China and global equity markets have reminded players not to get too complacent over any particular viewpoint and as ever, the need to apply proper risk management and follow sound trading rules is still the best advice.

The coming months promise to be extremely interesting times and we will keep you updated on any and all developments as they occur.

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