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ECB stimulus U-turn leaves markets unimpressed

11 March 2019

Last week, we wrote about the impressive 25% market recovery the Chinese stock market had witnessed since the beginning of the year. This week, the Chinese leadership demonstrated that it dislikes stock market exuberance at least as much as it does the credit excesses of the shadow banking sector. A ‘sell-note’ on one of China’s stock market darlings by a government-owned stockbroker caused market speculators to rush for the exit and sent the stock market down 4% in a single day.

Profit-taking became the theme of the week, with most markets closing slightly lower for the week. The European Central Bank (ECB) caused a negative reaction by deciding to join their US colleagues in easing monetary policy. To ease the tightening of liquidity from the end of its QE purchases, the ECB will reintroduce a bank refinancing instrument known by its great acronym of TLTRO. This should help to ease pressure on banks amid slowing European growth – a result of the global decline of demand from China and other Emerging Market economies.

European investors were not just being ungrateful compared to their US peers – where the Fed’s easing indications after Christmas initiated 2019’s recovery rally. Rather, investors were spooked by the ECB’s significant reduction in its growth outlook, which would suggest that much more easing may be necessary to really address the weakness. But the ECB is now very limited in their monetary policy, after their QE program has already purchased most of the government bonds they can buy without breaking their own rules. The fact that it’s now in the hands of politicians – not central bankers – to take action caused discomfort in the markets.

The seemingly never-ending impasse in the Brexit negotiations did not help. Once again, the much-expected final decision-making week for Parliament may once again not really come to pass. This further increases the chances that our expectation will be realised that no matter what, the formal Brexit will not happen on 29 March. Brexit will likely go into ‘overtime’ through an Article 50 extension. But this is not the only outcome that would extend the UK’s chronic uncertainty. Even if the government ‘deal’ somehow found a (pressed) majority in the end, it is dawning on the more forward-looking commentators that this may only mark the halfway point of trading uncertainty. With the final terms of any trade arrangement not part of ‘the deal’ we should expect a further two years of negotiation drama and uncertainty.

For UK-based investors, this would not constitute an overly adverse investment environment on the basis that, according to our assessment, worse has been priced in to UK asset prices already. However, they would have to endure another two years of political bickering here and elsewhere, while uncertainty keeps the country stuck in its rut – economically as well as politically.

Good then that progress appeared to happen elsewhere. The brewing geopolitical tensions between India and Pakistan that we suggested we needed to watch were just as swiftly and courageously defused by a grand gesture from Pakistan’s president and ex-cricket celebrity Imran Khan. Fingers crossed that his military continues to back him.

France’s president Macron provided another important step forward. In a European-wide newspaper article, he set out his vision for the EU’s future. While much focus was on his call for more cohesion and the fight against populism, his proposals for a pan-European immigration framework appeared much less noted. To my mind, such a step was inevitable given the rise of populism, but more importantly it could become a crucial factor in overcoming much of the future Brexit hurdles. The highly contentious red lines of free movement may be very helpfully qualified in the direction that a certain David Cameron pleaded for only three years ago.

Returning to the international arena, China’s annual People’s Congress provided some insightful guidance how the ever-pro-active Chinese leadership plans to address current challenges. The various economic stimulus measures put forward strengthen our view that China is in the process of stimulating domestic demand in a similar vein to 2016, which should spill-over into global demand channels and kick-start a rebound in the recently declining rate of growth.

It may sound strange, but the combination of the Chinese resurgence with the moderation of further US growth impetus may well help to stimulate global growth further. This is because this constellation is likely to lead to a softer US$, which should further stimulate global trade, just as the stronger US$ in 2018 harmed Emerging Market trade and business investment.