Rate Cut Mania Leaves Central Banks Struggling To ‘Out-Dove’ Market Demands

Jerome Powell isn’t the only central banker who’s under pressure to “out-dove” a “doved-up” market.

On Tuesday, data for May showed euro-area inflation fell more than anticipated, with headline printing just 1.2% in the flash read, while core fell to 0.8%. Both numbers represent a marked deceleration from April, and while that was expected, both prints missed estimates (consensus was 1.3% on headline, and 0.9% on core).

Again, nobody really “trusted” (if that’s the right word) the April numbers, which, while ostensibly representing another “green shoots” moment on the heels of relatively upbeat Q1 GDP data, were nevertheless given the “meh” treatment.

Tuesday’s numbers underscore the apparent intractability of the ECB’s inflation problem and, on the margin anyway, the disappointing figures for May raise the stakes a little more for Draghi this week. We previewed the ECB meeting on Sunday, imploring folks not to sleep on it. In order to impress the market, Draghi will likely have to unveil generous terms for the new round of TLTROs, enhance the bank’s forward guidance (i.e., push the first hike even further into the future) and, perhaps, hint that QE could be restarted.

Despite some green shoots having emerged of late, and although the EU elections did not produce the kind of populist wave some feared, the German economy is still teetering, as is the grand coalition — Nahles resigned on Sunday and Merkel has soured on AKK, which leaves both SPD and CDU in flux. Bund yields pushed to record lows last week and the threat of auto tariffs from Trump continues to cast a pall over the outlook for Europe. The Mexico escalation will only add to reservations in Brussels about the relative wisdom of negotiating with the US.

Complicating this for Draghi is the fact that despite negative rates and despite having only officially ended net asset purchases in January, the ECB is now behind the curve in terms of “active” easing. That is, although overall conditions in Europe may be more accommodative than they are in many other locales, the RBNZ has cut, the RBA cut on Tuesday and markets now expect the onset of an easing cycle in the US.

On the RBA, the bank delivered as expected and Lowe eventually said it’s “not unreasonable” that markets are priced for more cuts. Initially, the lack of forward guidance underwhelmed, and overall, the message wasn’t as dovish as some probably expected. That’s unlikely to deter anybody, though. After all, the market has been convinced for a while now that multiple cuts are in the cards down under.

Stateside, Monday was all about Fed cut expectations and Jim Bullard did his best to throw gasoline on an already raging fire. At this juncture, the only way to deliver a dovish surprise is for Powell to cut this month. Conceivably, he could put it off until July, but to the extent he cares about decorum, it would be more “natural” (if you will) to cut in June and then again in September, if necessary.

Although every meeting is “live” under this Fed chair (thanks to his penchant for press conferences), it would be hard to escape the perception that a cut in July represented something akin to panic unless there’s an almost explicit promise of imminent easing included in the June statement and presser. If the Fed has decided to cut before September (and it’s entirely possible that they haven’t), it’s not clear what purpose it would serve to put it off for one more month, unless the idea is to hope against hope that Trump comes to his senses on trade.

Coming full circle, the question for the ECB is how to avoid disappointing markets which are increasingly convinced that the coordinated dovish pivot from policymakers in 2019 is now set to morph into a full-on, honest-to-God coordinated easing cycle. Set against those expectations, and considering the political and economic backdrop across the pond, it’s hard to imagine how simply elaborating on the terms of the new TLTROs and pushing out the first hike by three months is going to be “enough” from the ECB.

In case this needed to get any more challenging, Draghi will need to avoid a repeat of March, when the cuts to the outlook were so steep that the dour message those downgrades conveyed about the economy overwhelmed the promise of more accommodative policy.

As BofA’s Hans Mikkelsen put it earlier this year, “communicating dovishness is always tricky as there is a delicate balance between the benefit of stimulus and the underlying driver, which is economic weakness.”