Insights
Macro Insights
ECB Action Puts Pressure on Fed
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Market Pulse
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September 16, 2019
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ECB Action Puts Pressure on Fed
ECB Action Puts Pressure on Fed |
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Valuing global interest rates is commonly done by relative comparisons. The European Central Bank’s (ECB’s) willingness to cut rates, along with an open-ended quantitative easing (QE) program that could amount to a projected €1.4 trillion in asset purchases, puts pressure on the U.S. Federal Reserve (Fed) to ease more aggressively in the quarters ahead.
The ECB Gets Ahead of the Curve, While the Fed Falls Behind
- The ECB’s September 12 rate cut and new round of bond purchases extends Mario Draghi’s reputation of doing “Whatever It Takes” to “However Long It Takes”
- The ECB cut rates by 10 basis points, from -0.4% to a record low -0.5%
- The stimulus package also revives the ECB quantitative easing program, buying a smaller €20 billion but committing to doing so “as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates”
- With the next rate hike not priced until six years from now, if the ECB buys €20 billion per month until just prior to hiking rates then this open-ended dynamic guidance would amount to approximately €1.4 trillion in asset purchases. This would be three to four times larger than any other QE program they have embarked on
- They also announced a tiered deposit rate to support banks, so credit can reach the real economy in a cost effective manner. This allows the ECB to reduce interest rates further without harming the banks
- For the Fed, two criteria will define success: a steeper yield curve and a weaker USD
- To avoid embedding deflationary expectations into the economy in a Japan-like scenario, the Fed needs to be proactive, not reactive in terms of policy
- Nevertheless, the Fed seems divided on policy, while the ECB seems unified in its view that adding accommodation is necessary
- The slower the Fed eases today, the more likely they will need to do later, and for longer
- An easing ECB is likely to push the Fed towards easing as well
- If the Fed lags the ECB in easing, the USD will likely strengthen, which will be negative for growth globally and will in turn force the Fed to ease more later on
- We expect the Fed to cut two more times this year and at least another two more next year, for about 100 basis points more of cuts
- Easing sooner rather than later would also show the market that the Fed is proactive and ahead of the curve. It would rebuild inflation expectations and term premia into the curve, re-steepen the yield curve, and on a relative basis weaken the dollar, or at lease soften its rally
The Absence of Negative News Is Positive for Markets: A Contrarian Bull Case Scenario (for Now)
- The U.S.-China trade war appears to be moving toward a cease fire (for now)
- The risks coming out of BREXIT and Italy are down (for now)
- While corporate leverage is high, the cost of servicing that debt is very low
- There is a lot of global stimulus in the system, which could gain traction in stable markets
- While survey-based data like PMIs and sentiment have fallen sharply, they can reverse just as quickly
- Global PMI Index rose for the first time in 16 months
- The surprise pushed indices sharply higher, as expectations were very weak
What are we doing from an investment perspective?
- We are moving duration from long to neutral, and may move to short (e.g., U.S. Treasuries)
- And finding pockets of opportunity in sectors that have lagged behind
- Emerging Markets (select areas):
- Steeper curves, higher real rates, central banks with scope to cut
- High Yield:
- Consumer cyclicals, building material, transports and the energy sector
- While moving down in quality away from BBs into Bs and select CCCs
- Investment Grade:
- We still like regulated sectors (e.g., financials and utilities)
- But are also finding value in delevering stories (Telecom)
- Retailers and consumer-related sectors
- And see BBBs as the sweet spot in the capital structure
- Emerging Markets (select areas):
RISK CONSIDERATIONS
There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In the current rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. Longer-term securities may be more sensitive to interest rate changes. In a declining interest-rate environment, the portfolio may generate less income. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. High-yield securities (“junk bonds”) are lower-rated securities that may have a higher degree of credit and liquidity risk. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. Foreign securities are subject to currency, political, economic and market risks. The risks of investing in emerging-market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk).ties (liquidity risk).
September 2019
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Please consider the investment objective, risks, charges and expenses of the fund carefully before investing. The prospectus contains this and other information about the fund. To obtain a prospectus, download one at morganstanley.com/im or call 1- 800-548-7786. Please read the prospectus carefully before investing.