A reduction in quantitative easing stimulus – weekly update 30 October 2017

A reduction in quantitative easing stimulus

The European Central Bank (ECB) reduced its quantitative easing (QE) stimulus broadly in line with expectations. The Central bank will ostensibly halve the purchase rate from €60 billion per month to €30 billion from January and extend the programme through until September. As always, the devil was in the detail. Whilst the new purchase rate was cut, the bank also highlighted that it would be flexible in the reinvestment of maturing assets, which effectively increases the level of ongoing stimulus closer to €45 billion per month. There was also some disappointment for hawks as the ECB President, Mario Draghi, effectively committed to keeping the programme open-ended and providing stimulus for as long as was needed – possibly even increasing the purchase rate if conditions deteriorated. Mr Draghi also reiterated that interest rates would remain at a very low level until well past the end of QE. Although at very different stages, the ECB is taking a similar approach to the Fed, carefully managing market expectations and taking an especially gradual approach to reducing monetary stimulus. This caution should help to anchor long rates, though the distorting effect that QE has had in European fixed income markets, where the ECB has been the main buyer of government bonds, could cause some volatility at the short-end of the curve.

Third quarter GDP figures for both the UK and the US beat expectations

The UK saw quarter-on-quarter (qoq) growth of 0.4% from July to September, slightly ahead of the 0.3% expected and a pick-up from 0.3% in the second quarter as services and manufacturing activity continued to expand, though construction activity contracted during the quarter. The year-on-year (yoy) rate remained unchanged at 1.5% as expected. In the US, third quarter GDP shook off the effects of hurricanes Harvey and Irma to expand at an annualised rate of 3.0% – a marginal slowdown from the 3.1% reading for Q2, but comfortably ahead of the 2.6% forecast. Strong consumer activity was the key driver, supported by positive real earnings growth as well as a tick down in the savings rate. There was also a notable contribution from inventory building, though this can be a more ambiguous signal.

The US also had encouraging PMI readings, whilst the Eurozone’s numbers were mixed

The Markit PMI numbers for the US showed an improvement ahead of expectations for both Manufacturing (53.1 to 54.4, 53.4 expected) and Services (55.3 to 55.9, 55.2 expected) measures, supporting a view of continued resilience in the world’s largest economy. Eurozone Manufacturing was also encouraging, up from 58.1 to 58.6 (a slip to 57.8 was expected), though the much larger Services sector disappointed, down 0.9 points to 54.9 (55.6 was expected). In Japan, Manufacturing PMI was also a little softer, down from 52.9 to 52.5.

Last week’s other events

• Tensions in Spain remained high, as the regional Catalonian government declared independence following its controversial referendum earlier in the month. In response, the Spanish government in Madrid moved to suspend the region’s autonomy.
• US Durable Goods Orders came in better than expected, rising from 2.0% to 2.2% yoy against forecasts for a fall to 1.0%.
• The UK Business Optimism survey index has continued to fall, most recently from 5 to -11.
• In Japan, CPI inflation was unchanged, as expected, at 0.7% yoy. The less volatile measure, which strips out food and energy components, was unchanged at 0.2%, also as expected.

The markets

The slightly softer-than-expected announcement from the ECB helped nudge the euro lower and drive a rally in German bunds, whilst Japanese equities continued to rise following the election.

Equities – It was another strong week for Japanese equities, as the TOPIX index gained 2.3%, the only major index to make an overall move of more than one percent. Continental Europe (MSCI Europe ex-UK) returned 0.9%, with the US’s S&P 500 up just 0.2%. UK equities (MSCI United Kingdom) was slightly negative, falling -0.1% with Emerging Markets also marginally down as the MSCI Emerging Markets index fell -0.2%.

Bonds – Movements were mixed on the sovereign bond market this week, driven by a range of more regional factors, but it was another period in which the size of the moves were fairly limited. US and UK 10-year bond yields were up early in the week, but fell back somewhat over the last couple of trading days. Overall US 10-year yields were up 2 basis points (bps) to 2.41%, and UK 10-years were also up 2 bps to 1.35%. In contrast, the ECB announcement was enough to push German bond yields down, with the 10-year falling 7 basis points to 0.38%.

Commodities – The oil price continues to drive higher, with Brent Crude breaking through the US$60/barrel mark for the first time in over two years, ending the week at US$60.44/barrel. Gold slipped to US$1,273/ounce and copper was also weaker at US$3.10/lb.

Currencies – The euro was the main mover on the week, falling against major currencies after the ECB on Thursday. The Japanese yen and US dollar was marginally stronger against sterling. Sterling closed on Friday at $1.31, €1.13 and ¥149.

1 month performance of major asset classes

The week ahead

It’s a very busy week ahead, with several key events to take note of. The main event will be the Bank of England’s Monetary Policy Committee meeting on Thursday, where the committee is expected to increase rates for the first time since June 2007. We also have the equivalent Bank of Japan meeting Tuesday morning (UK time), and the US Federal Open Market Committee meeting on Wednesday. Nothing is expected from either of these meetings, especially following the recent Fed activity, but on a related note, we are expecting to find out who the next Federal Reserve Chairperson will be, which could give people plenty to talk about. It’s rare for Friday’s Non-Farm Payrolls to be something of a sideshow for the week, but it still has the potential to impact markets, where the street is expecting the headline rate to rebound to 310,000 jobs added, after the hurricane-induced swoon to -33,000 job losses last month. The daily breakdown is as follows:

Monday: Japanese retail sales figures are released overnight. Later in the morning, UK Net Consumer Credit figures from the Bank of England are out, along with the latest money supply figures, and we also have Eurozone business confidence survey results. In the afternoon, we have US PCE inflation to look forward to (1.6% yoy from 1.4% expected), which is the Fed’s preferred measure of inflation. Late in the evening, Japan reports Industrial Production numbers.

Tuesday: We start with UK Consumer Confidence from GfK and the Lloyds Business Barometer reported just after midnight, as well as the output from Bank of Japan. This is followed by official readings of Chinese PMI for both Manufacturing and Non-Manufacturing. Eurozone CPI inflation is out mid-morning (no change at 1.5% yoy expected). The afternoon is fairly quiet, with the US’s Employment Cost Index for Q3 and Conference Board survey sentiment data expected.

Wednesday: A minute after midnight the UK Shop Price index is reported from the British Retail Consortium. Chinese Manufacturing PMI from Caixin, the private measure (no change at 51.0 expected), is also out, followed later in the morning by the UK Manufacturing PMI reading from Markit (no change at 55.9 expected). In the US, ahead of the FOMC meeting conclusion, the ISM reports US Manufacturing PMI (a slip from 60.8 to 59.4 is forecast).

Thursday: UK Construction PMI (48.5 expected from 48.1) is the only notable release before we get the Bank of England decision on monetary policy, covered above, which also comes with the quarterly Inflation Report of economic forecasts.

Friday: Chinese Services PMI is reported by Caixin early in the morning, with UK Services out later (a slip from 53.6 to 53.3 is expected). The afternoon has US Non-Farm Payrolls, as above, with associated data such as average earnings, participation ratio and underemployment also of interest.