Global Rates: As Fed Turns Dovish, ECB And BoE Could Surprise With Hikes In 2019
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(Kitco News) - Markets will be on the lookout for any changes to global monetary policy in 2019, with analysts paying a special attention to the Federal Reserve (Fed), the European Central Bank (ECB), the Bank of England (BoE), the Bank of Canada (BoC), and the Bank of Japan (BoJ).
Paths of major central banks will diverge next year, according to analysts, who see the Fed as more dovish and the ECB along with the BoE as more hawkish in 2019.
Federal Reserve To Be More Dovish In 2019
Despite hiking interest rate by another 25 basis points to a range of 2.25% to 2.50% on December 19, the Federal Reserve also lowered its rate hike expectations for next year, citing financial market volatility and slowing global growth.
“Ultimately what we’ve seen is the Fed coming up a little bit more dovish than previously by moving its dot plot lower — now expecting just two rate hikes next year instead of three,” TD Securities head of global strategy Bart Melek told Kitco News.
Fed Chairman Jerome Powell also said at a press conference following the December announcement that interest rates have hit the lower bound of the central bank’s range of estimates for the neutral rate.
While the U.S. economy is expected to continue to grow next year, the pace is expected to slow — growing 2.3% next year, down from 3% growth expected in 2018, Powell added.
This will be an adjustment for the markets, which were pricing in an aggressive Fed just a few months ago.
“We appear to be going to the top of the rate hike cycle. If inflation stalls next year, there would be less impetus for the Fed to raise rates much further as not to cut the GDP growth,” Mitsubishi analyst Jonathan Butler said in a telephone interview.
Another major change in 2019 will be more press conferences — one after every Federal Reserve policy meeting. This kind of attention from Powell will alter how markets interpret Fed’s decisions and communications.
“Next FOMC meetings are January 30 and March 20. Market puts very low odds on a move at either meeting, and rightfully so. However, with a press conference after every meeting, perhaps the Fed will be able to get its message across a little better in 2019,” said analysts at BBH Global Currency Strategy.
The Fed will be paying close attention to global developments next year, but the biggest factor for the central bank will be employment growth, said Westpac global head of market strategy Robert Rennie.
“If you look through the past three tightening cycles in 1995, 2000 and 2006 and see what ultimately led the Fed to pause, you’ll notice that the Fed responded to a slowdown in employment growth, spending, housing and durables. We are still expecting employment growth closer to 2% next year. But, in 2006, for example, the annual employment growth dropped from just about 2% to 1%, which forced the Fed to go on hold.”
Rennie added that Westpac sees U.S. employment growth slowing by mid-next year and then falling closer to 1% by year-end, which could mean a prolonged pause in tightening. “And that pause could be for a lengthy period of time,” he said.
Other economists are also looking for the Fed to end its current tightening cycle by the second half of next year.
“We are forecasting an end to Fed tightening by the middle of next year … and we foresee the Fed [starting to] cut interest rates in 2020 by a greater amount than the market expects,” said economists at Capital Economics.
Capital Economics is currently projecting two more rate hikes in 2019 — during March and June meetings.
This dovish shift will be in contrast to other major central banks that are starting to tighten next year, including the European Central Bank (ECB).
ECB Could Hike As Soon As Fall 2019
The latest announcement from the European Central Bank was a halt to its €2.6 trillion ($2.9 trillion) stimulus program scheduled for January despite concerns of an economic slowdown in the EU over the next couple of years.
“The balance of risks is moving to the downside owing to the persistence of uncertainties related to geopolitical factors, the threat of protectionism, vulnerabilities in emerging markets and financial market volatility,” ECB President Mario Draghi said after the latest rate decision on December 13.
The central bank also downgraded its economic outlook for 2019, stating that it sees the eurozone economy as growing by 1.7% next year, down from September’s forecast of 1.8%, and inflation rising 1.6% next year, down from the previous forecast of 1.7%.
Once again, the ECB left the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility unchanged at 0.00%, 0.25% and minus 0.40%, respectively.
Next year, markets might see the ECB begin to hike rates in Q4, said Governing Council member Olli Rehn.
“Markets appear to be reading the ECB’s forward guidance correctly,” Rehn told YLE Radio 1 back in October. “The starting point should be that if the economy develops roughly in line with the current outlook, the first rate increases would take place in the final quarter of 2019.”
RBC Capital Markets noted that it doesn’t expect the ECB to be too aggressive in terms of rate hikes.
“We do think the ECB will steer expectations away from a fully-fledged hiking cycle beyond removing negative interest rates,” RBC strategists said. “We still expect the first ECB rate hike in September 2019. Crucially, however, we expect the ECB to use more forward guidance to temper expectations for the period after key rates have reached positive territory again.”
Top risks on the ECB’s mind include the U.S.-China trade war, Brexit, and the Italian budget issues.
The U.S.-China issue will be the first one to unfold, said Refinitiv director of metals demand Cameron Alexander.
“The U.S. has given 90 days for China to come to the table with a solution. We will get to that point early next year and that could be a tipping point as well in terms of what happens,” Alexander noted.
There is also an appointment of the new ECB president to pay attention to next year, as Draghi’s term expires in October 2019.
It is widely debated who will succeed Draghi in 2019, with ABN AMRO head of financial markets research Nick Kounis highlighting ECB executive board member Benoit Coeure as the candidate that “stands out” due to Coeure’s proximity to current policy making.
Another much talked about frontrunner for the ECB president position is the former Finnish central-bank governor Erkki Liikanen, noted Bannockburn Global Forex chief market strategist Marc Chandler.
The European Parliamentary elections will also take place in May, with the rise of euro-skepticism keeping investors on their toes.
“We have projected that Eurosceptic parties on aggregate will increase their seats in the European Parliament in the next election making a representation of just over 33%. This means that they will have significant power to disrupt the policymaking process of the European Union,” RBC Capital Markets said in a report.
The BoE Is Ready For Hikes If …
During its last monetary policy meeting in December, the Bank of England kept interest rates on hold at 0.75%, warning that consumer demand and business investment suffered due to Brexit uncertainty.
“Heightened Brexit uncertainties were evident across a range of domestic financial markets,” the BoE stated.
The Bank’s monetary policy committee (MPC) added that if Brexit goes smoothly next year, then “an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate.”
Analysts are projecting a more aggressive BoE next year if all major hiccups are avoided in March 2019 — when the UK is due to exit the EU next year.
“Money markets are currently not making sufficient room for potential rate hikes. Labour markets are tight, hiring intentions strong and the first tentative wage pressures are emerging, particularly in the UK,” the strategists at the RBC Capital Markets said. “Assuming the UK can reach a transition period in its EU negotiations, we expect two BoE rate hikes triggering substantially higher real yields along the curve.”
Similar outlook came from the J.P. Morgan Asset Management: “By the end of the year it will be clear that the U.K. is headed towards a softer Brexit and that the Bank of England will raise rates in 2019 more than the market is currently priced,” said the firm’s chief market strategist Karen Ward.
The first possible move higher could come as early as February and the second as soon as November, RBC added, describing the Bank as “itching to increase Bank Rate.”
But, it is important to keep in mind that in the event of “no deal” Brexit, the BoE is likely to revert back to cutting rates, the RBC warned.
Currently, the RBC is pricing in a pickup in growth to 1.5% in 2019, led by stronger investment spending and higher government spending.
The BoC Down To Two Rate Hikes Next Year
The Bank of Canada (BoC) kept rates unchanged at 1.75% during its most recent monetary policy meeting in the beginning of December, citing lower oil prices.
“The persistence of the oil-price shock, the evolution of business investment and the bank’s assessment of the economy’s capacity will also factor importantly into our decisions about the future stance of monetary policy,” the bank said.
Following the meeting, some economists have downgraded their rate hike expectations for next year, stating that only two more hikes are likely in 2019.
“We think two rate hikes are on the docket for 2019, which is a downgrade from our prior view of three hikes in light of the recent domestic risks that have emerged and some unexpected weakening in economic momentum,” TD Securities chief economist Beata Caranci and senior economist James Orlando said in a report.
The balance of risks for the BoC is more to the downside than that of the Fed, TD’s economists noted, highlighting overstretched Canadian households and the most recent shock from energy markets.
“Even with the Bank of Canada’s inflation mandate essentially filled, there are risks to the outlook that are unique to Canada and may slow the timing of rate hikes. The most familiar of these is the long-standing risk related to over-leveraged households that may belt tighten more than expected,” Caranci and Orlando said.
The most likely scenario, according to the economists, is for the BoC to make another move on rates during the spring period.
“Our tracking for real GDP in the fourth quarter of 2018 is below the Bank of Canada’s 2.4% forecast by roughly a full percent (annualized). This suggests the timing of the next rate hike would be better suited for the March/April period, even though financial markets currently have high hopes of a rate hike come the January 9th meeting,” they added.
Capital Economics also said that it is sticking to its two rate hikes forecast for next year, noting that 2.25% would mark a peak for rates, with the BoC likely pausing after that for the rest of 2019 and 2020.
The BoJ Diverges From Other Major Central Banks
The Bank of Japan maintained its loose monetary policy during its latest meeting, which took place on December 20. The central bank said that it is keeping the short-term interest rate target at minus 0.1% and the 10-year bond yield target at around 0%.
The biggest obstacle for the BoJ has been weak inflation, with the central bank admitting that Japan’s economy will not be able to reach its target of 2% before fiscal 2020.
The most recent inflation data out of Japan showed that the national core consumer price index (CPI), which excludes food, rose 0.9% year-on-year in November. This convinced many analysts that the BoJ is likely to hold off from tightening its monetary policy.
“The only game in town is achieving the target. Tightening now is not going to help you get there. They’re very much committed to reaching the target, and we think that’s the right thing to do,” IMF’s mission chief for Japan Paul Cashin told Reuters last week.
Earlier in December, Bank of Japan Governor Haruhiko Kuroda ruled out any chance of a near-term interest rate hike, stating that any tightening at this point could delay inflation from achieving its 2% target.
“Risks to Japan’s economy are tilted towards the downside. We need to pay particular attention to protectionist moves such as the Sino-U.S. trade friction,” Kuroda said in a speech on December 5. “Raising interest rates now to create policy space for future economic downturns may risk delaying achievement of our inflation target.”
Despite Kuroda’s conviction, the minutes from the October monetary policy meeting released this week showed that there was a division within the central bank, with some BoJ policymakers questioning the sustainability of the massive stimulus program.
“If the long-term rate target was maintained around zero percent for a long time, the positive effect of monetary easing on inflation expectations could diminish,” one member was quoted as saying.
The most likely outcome for 2019 is a loose monetary policy from the BoJ in order to support inflation, according to FocusEconomics.
“The majority of analysts FocusEconomics polled [in December] expect the Bank of Japan’s short-term policy rate to remain at minus 0.10% through to the end of 2020. The 10-year bond yield is expected to be 0.15% at the end of 2019, before rising to 0.29% at the end of 2020,” FocusEconomics said.