2018 has been defined by divergent growth paths between the U.S. and the rest of the world and that divergence is part and parcel of the narrative that’s driving the disparity between the performance of U.S. equities and their global counterparts ever wider.
Q1 marked a rather stunning deceleration in Eurozone economic activity and the slowdown came just as market participants were pondering the ECB’s QE exit plan.
ECB officials were keen to play down the Q1 weakness as “transitory” because, well, because if it proved to be a harbinger of a prolonged downturn in the eurozone economy, the stage would be set for “quantitative failure“, a scenario where the central bank ends up confronting a recession while still mired in NIRP and still saddled with a bloated balance sheet. That’s the dreaded “out of ammo” problem.
Of course Mario Draghi pushed ahead despite the poor data, announcing asset purchases will end in December after a taper to €15 billion next month. That, even as the political situation in Italy seems to tip an inevitable budget clash between the country’s populist government and Brussels. Draghi’s move to pair the QE wind down announcement with the introduction of state-and-date-dependent rates guidance helped soften the blow and actually managed to turn an otherwise hawkish decision into a dovish miracle.
In any event, if you put any stock in Citi’s economic surprise indices, you’ll be interested to note that things have turned around. For the first time since Q1, Citi’s surprise index for the U.S. is more negative for the U.S. than Europe.
(Bloomberg, h/t Lisa who flagged this on Tuesday morning)
Is this the economic precursor to the convergence JPMorgan’s Marko Kolanovic is now calling for in equity markets? Who knows, but it’s welcome news if you’re a euro bull, especially in light of how the turmoil in Turkey has weighed on the single currency. EURUSD hit a two-week high on Wednesday, and is one pace for its sixth straight gain.
That’s good for Trump’s trade war with America’s European “foes“, but it hurts his economic bragging rights. When it comes to European equities, this will just be a matter of what the market cares about more, a firmer bloc-wide economy or the potential headwind from a stronger currency.
It’s welcome news for the ECB, that’s for sure (unless you’re in the camp that thinks Draghi is looking for an excuse to extend accommodation). Remember, this is what BNP thinks would happen in the event the central bank were to find itself staring at a recession without having normalized:
Moreover, if experience of the great recession and the euro crisis is a guide then core inflation might fall by 1% or so, requiring, according to the Taylor rule, cuts of another 150bp. Thus a recession could require rates to be cut to -250bp. This hardly looks feasible.
A return to QE would look all but inevitable, though for several countries ECB holdings of bonds are close to the 30% limit the ECB has set itself. There is a high probability this limit would be lifted — maybe as far as 50%. Along the way, legal challenges to the ECB breaking the monetary financing rule would be likely, even more so if the 50% barrier were crossed. Purchases of other assets would come into question, as the ECB’s Mr CÅ“uré has suggested.
