Week in Focus; week commencing 8 April 2019
Another busy week in Westminster once again saw stalemate in the Brexit process continue to delay the UK’s exit from the EU. To recap on recent events, the government refrained from taking PM May’s deal back to the House of Commons for a fourth time, and instead, PM May opted to try and strike a cross-party solution with opposition leader Corbyn. At the time of writing, talks are ongoing between the two parties. However, the broad inference from the move by May is that the UK could be heading towards a ‘softer’ form of Brexit in order to secure Parliamentary backing. Naturally, this has only acted to exacerbate the divisions within her own party; however, as it stands, there has been a lack of high-level departures from the cabinet, albeit there were reports last in the week suggesting that some cabinet ministers had discussed a mass walkout in protest against a prospective soft Brexit and long delay to Article 50. An extension to Article 50 appears to be almost inevitable with PM May sending a letter to EU Council President Tusk proposing an extension to Brexit until 30th June 2019 with the potential to terminate early should a deal be ratified before then. The letter also stated that the UK will begin to prepare to host European elections, which will likely further inflame the situation within her own party. From an EU perspective, the BBC reported that Tusk is preparing to offer a 12-month ‘flexible’ extension, subject to approval by EU leaders. This brings us onto potentially the most important Brexit-related date for our diaries next week – 10th April; the EU Council meeting which will see Tusk seek approval for his offer. At the time of writing, it appears that EU leaders would approve an extension to Brexit, however, Buzzfeed reminds us that “not all leaders are (yet) on board with the idea of a long flexible extension”. This sentiment was reinforced by sources closes to French President Macron suggests that talk of a further extension to Article 50 is premature as the criteria for obtaining one (a credible alternative plan) has not been met yet. The sources also stated that the UK needs to provide a blueprint by Tuesday, thus, placing further pressure on Mrs May to reach some form of compromise with Jeremy Corbyn.
With this week’s account of the March meeting providing little in the way of new info for markets, attention turns towards the April policy announcement. Ahead of the decision, a lot of the narrative from central bankers at the ECB has centred around the possibility of tiered rates. This was triggered by comments from President Draghi who stated, “we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any”. This prompted markets to speculate about whether the Bank was considering the prospect of a tiered deposit rate system. These suspicions were later supported by sourced reports stating that ECB staff are working on models for a tiered deposit rate and options to return some but not all of the cash it collects from a charge on excess liquidity. As such, the prospect of a tiered rate system will remain a key focus for markets with ING highlighting four considerations for the Bank should they introduce such a measure: 1) It could be perceived as a sign that the ECB is preparing for a “low for much longer” period and even open the door for further rate cuts. 2) It could actually complicate the pass-through of monetary policy to the real economy. 3) Could be perceived as yet another “free lunch” for the banking sector. 4) Potential further cuts would mainly be seen as exchange rate manipulation rather than supporting the bank lending channel. That said, Chief economist Praet and policymaker Knot reminded markets that the monetary policy case still needs to be made for such a system and thus April will likely be too premature for such an announcement at this stage. Elsewhere, investors will be looking out for any further hints on what to expect from the Bank’s recently announced TLTRO3. However, HSBC cautions that “given that there is no pressing need to announce the final details, the ECB may therefore decide to wait for a bit more data before nailing down the final details and keep us waiting until June”. Finally, as ever, the overall tone of the press conference will be eyed given some of the recent downbeat manufacturing indicators from the region which raised further questions surrounding the Eurozone’s 2019 growth outlook. Market participants will be looking to see whether this sentiment is reflected in the Governing Council’s assessment of the economy and whether the ECB believes that the convergence of inflation towards its aim has been ‘delayed not derailed’.
At the March meeting, the Fed kept rates unchanged at 2.25-2.50%, as expected. The trajectory of rate hikes was narrowed, as expected, with the central bank now seeing no rate hikes in 2019, and one in 2020 (it previously saw three hikes over its horizon); it left the neutral rate estimate at 2.8%. Forecasts also showed the Fed sees weaker near-term economic growth and tamer inflation conditions when compared with December. The Fed also stated that it will slow the balance sheet run-off beginning in May and ending in September, adding that it would reduce the cap on monthly redemptions to USD 15bln (Prev. 30bln), and reinvest MBS coupons into Treasury holdings, starting in October; the Fed said it would provide more details in May. The Fed Chair began reiterating patience ('no need to rush to judgement') and the 'wait and see' approach, though still sounded relatively upbeat about the economy ('The Fed's outlook is a positive one' and 'underlying economic fundamentals are still strong'), while noting international risks (trade, Brexit, China, Europe - although he notes China is stabilising, and he does not foresee a recession in Europe). Powell said it could be some time before the outlook calls for a change in policy. On the balance sheet, Powell said that reserve balances in September might still be above what is required for the efficient delivery of monetary policy, and the Fed could still tweak the BSN plan, if conditions warrant. Powell did disclose that the balance sheet's size will be approximately 17% of GDP by the end of this year at a bit above USD 3.5trln (vs around 25% of GDP at its peak near the end of 2014); on its composition, the Fed chair said the FOMC's decision will turn to that shortly. Powell said financial conditions are more accommodative now than a few months ago. Tariffs got another mention, and the Fed chair said for the US economy, he was hearing concerns about tariffs, but it was hard to say how much of an impact this was having. It was interesting that Powell said that rates are in the range of neutral, despite the median dot being unchanged at 2.8% (two 25bps hikes away from the current FFR target). Powell continued on his inflation views that he made a couple of weeks ago, arguing that the Fed has not achieved its objective, and that is another reason why it is being patient. On the yield curve, Powell was asked whether the Fed is trying to flatten the yield curve, to which he replied 'no'. Net/net, the reaction was distinctly dovish, with money markets now pricing the possibility of a rate cut in 2019 at just under 40% after the meeting vs around 25% the day before; since then, that dovish pricing has continued, and at pixel time, money markets are pricing around a 50% chance the Fed will reduce rates in 2019.
The Street looks for CPI (Weds) to come in at 1.8% Y/Y (and 0.3% M/M) in March vs a previous 1.5% (and prev. 0.2%); the core rate is likely to remain unchanged at 2.1% Y/Y (0.2% M/M). Analysts at Nomura are less optimistic than consensus and have pencilled a below trend 0.1% M/M in the core rate, which it warns could lower the Y/Y core rate to 2.0%. "Used vehicle prices likely faced downward pressure based on vehicle market conditions, with higher rates and increased supply, along with incoming data from Manheim. In addition, we expect that apparel prices declined by 0.4% m-o-m after back-to-back steady increases over January-February, similar to the pattern from Q1 2018." Nomura also says that the impact from higher tariffs appears to be waning, and additionally it is possible than prescription drug prices rebounded in the month modestly; "These factors suggest little upside risk to core goods prices in March. We think core service prices increased at a trend-like pace."