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Accommodative central banks : The force awakens

23 April 2019

The central banks took centre stage once again in March, with the ECB meeting early in the month followed by the Fed a couple of weeks later. Given the impact their decisions have across all asset classes, a number of aspects merit a closer look:

Accommodative central banks : The force awakens

The ECB has adopted an extremely accommodative tone, on a range of issues:

  • Change in forward guidance by promising not to raise its key interest rates before the end of 2019 (vs summer 2019 previously);
  • Launch of a new series of TLTROs from September, each with a maturity of two years;
  • Bigger than expected downward revision in growth and inflation forecasts.

We could also mention the "tiering" system Mario Draghi has alluded to since the meeting, which if implemented, could enable the ECB to lower its policy rates again.

The Fed, meanwhile, was even more accommodative than the ECB relative to market expectations:

  • End of balance sheet shrinking in October 2019;
  • Downgrade in Fed members’ median forecasts, which now indicate a single hike to end-2020, versus three previously;
  • Growth forecast for 2019 cut to 2.1% from 2.3% previously.

These decisions by the Fed are surprising in view of the current situation in the US economy, which has barely changed since September, whereas the Fed’s message is markedly
different.

On the other hand, these decisions are not so surprising given the financial conditions (and movements on equity markets) over this period. However, we wonder if it was really necessary to go so far at the last meeting, when the financial conditions are already generally better than they were at the start of the year.

The macroeconomic environment has looked to be improving in recent weeks, with reassuring figures coming out of China, which is consistent with the substantial fiscal,
budgetary and monetary stimulus implemented a few months ago; this improvement is likely to have further to go. The eurozone seems to be stabilising, despite the German automotive sector continuing to weigh on the bloc as a whole; however, we think that the downgrades to eurozone growth forecasts are now behind us.

What should we do in this environment? With growth stabilising, inflation risk low and the central banks extremely accommodative, the scenario for income-generating assets is very favourable overall. Moreover, this situation should also favour equity assets, provided the exogenous risks remain in check. Lastly, given the very sharp drop in returns on risk-free assets and an improving macroeconomic outlook, we could see a modest rise in these assets in the coming weeks.

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