BMA Market Insights: Central Banks Consider Accommodative Measures as Global Growth Concerns Linger

RISK-ON sentiment overnight after the Trump administration held off plans for punitive tariffs on Mexican imports. Equity futures and rates higher across the board. USD higher against the euro and pound. The 10-year U.S. Treasury note is trading 6.2bps higher to 2.141% as of this writing.

The futures market no longer seem to question if the Federal Reserve will cut its key policy rate, but rather as to when the Fed may take a more accommodative approach. Fed futures reflected an increased probability of a quarter-point rate cut for July, last week, amid a weakened economic outlook and lingering trade tensions. Further, Fed officials, including FOMC Chairman Powell recently noted that both the impact of trade strife and stubbornly low inflation levels may prompt the Fed to cut rates.

Investors will largely scrutinize trade developments and its impact on inflation, with an additional eye on industrial production and retail sales data which are all scheduled to be released by key global economies throughout this week (see more below). Downbeat data could elicit lower growth forecasts as a sluggish global economy weighs on the markets.

This sentiment was reinforced last week by soft manufacturing data released across major markets, including the U.S., U.K., Canada, and the EU. Economic data coupled with the weakened macro outlook have recently triggered a number of central banks to either implement or consider more accommodative monetary policies.

While the European Central Bank left its policy rate unchanged last week, the bank shared further details regarding its stimulus measure surrounding the targeted longer-term refinancing operations or TLTROs (see more below). The Reserve Bank of Australia, who also met last week, cut its policy rate for the first time in nearly three years. The RBA is not alone, in recent weeks, central banks in both New Zealand and India cut their respective policy rates. Similarly, the People’s Bank of China’s chief, Yi Gang, signaled the bank’s readiness for further economic stimulus.

Closer to home, Powell not only indicated the possibility of a rate cut but mulled the challenges presented by a low-interest rate environment. Should another economic crisis come to fruition in a low rate environment, the Fed may then have fewer tools to stimulate the economy. Nevertheless, the Fed was provided further impetus to cut rates on the back of a weaker-than-expected May U.S. jobs report (see more below).

The increased potential of the Fed providing a more accommodative monetary policy spurred the market to rally last week. All three major U.S. stock indices closed the five-days in the green, with the S&P 500 capping the week at 2,873.34. Similarly, demand for Treasuries edged higher, pushing yields lower as the 10-year traded around 2.08% at the close. Finally, while oil took a beating on economic growth concerns, some downward pressure was alleviated on the back of Saudi Arabia telling OPEC and its allies that supply cuts should be extended. WTI crude hovered around $54.03/barrel at the close.

I. U.S. Economic Data/Markets

The unemployment rate held steady in May at 3.6%, near a 50-year low. Other takeaways from the unemployment report included:
- Wages increased by 3.1% y-o-y.
- About 75k jobs were added, below estimates of 185k.
- Government and retail trade sectors saw a decline in hiring compared to the previous month. Conversely, the professional/business services and leisure/hospitality sectors saw an uptick.
- Both April and March data were revised lower. April’s number was revised to 224k from 263k and March’s job count dropped by 36k k to 153k.
The trade deficit narrowed in April, falling to $50.8 billion, in line with expectations. Exports fell $4.6 billion to $206.8 billion and imports declined $5.7 billion to $257.6 billion.
Fed’s Beige Book indicated a modest pick-up in growth, although the data was collected prior to renewed trade tensions between the U.S. and Mexico.
ISM Non-Manufacturing index surprised to the upside rising to 56.9 in May from 55.5 in April. Forecasts largely predicted the level to remain unchanged.
Factory Orders declined by 0.8% in April. The data was driven by a drop in demand for iron, steel, construction machinery, computers, autos, and passenger planes, with shipments dropping the most in two years.
Fed Chairman Powell suggested that the Fed could cut interest rates if the economic outlook deteriorated on the back of escalating trade tensions. Other takeaways from his speech included:
- The challenges presented by a low rate environment, which would leave the Fed little room to cut rates in an economic downturn.
- Concerns surrounding persistent low inflation and how that may influence the expectations of future inflation.
Fed Official Quarles urged market participants to be prepared for a shift away from LIBOR.
- Noted that it is important for prudent risk management and one’s fiduciary responsibilities to move away from LIBOR as soon as practically possible. The suggested successor to LIBOR in the USD market, SOFR (secured overnight funding rate), has yet to be widely embraced by the market.
Fed Official Bullard noted that low inflation and lingering trade tension and uncertainty may prompt the Fed to cut rates.
ISM Manufacturing fell to 52.1 in May, the lowest reading since October 2016 and below forecasts of 53
Markit Manufacturing PMI came in at 50.5 in May, a drop from April’s 52.6 reading and lower than forecasts of 50.6. It was the lowest reading since the crisis in 2009.

II. Trade

Sino/U.S. – the Trump Administration announced on Friday it would delay tariffs on Chinese goods set to rise to 25% on June 1st to remain at 10% until June 15th. A detailed list of what goods would continue to have the 10% rate remained unclear.
Mexico/U.S. – came to an agreement that included Mexico taking strong measures to curb illegal immigrants coming into the U.S. In turn, the Trump Administration agreed to indefinitely suspend tariffs on Mexican goods that were originally meant to kick in on June 10th.
Brexit – Theresa May resigned as the Conservative Party Leader on Friday, as expected, given her inability to deliver an actionable Brexit proposal. Her replacement is expected to be announced the week of July 22nd.

III. Non-U.S. Economics

Eurozone Economy
- European Central Bank left interest rates on its key deposit facility unchanged at -0.40%. The bank surprised the markets by stating its expectations that rates will remain at their present level at least through the first half of 2020 with President Draghi noting that some officials were contemplating a rate cut.
  - The bank expressed concerns surrounding uncertainties related to geopolitical factors, protectionism threats and vulnerabilities within emerging markets – all of which could impact economic sentiment to the downside.
  - Regarding its new targeted longer-term refinancing operation or TLTRO, the ECB will give banks credit at rates 10 basis points above its minus 0.4% deposit rate.
  - Changes to the bank’s economic forecasts included:
    - GDP growth in 2019 at 1.2%, up 0.1% from its March forecast. GDP for 2020 at 1.4%, down 0.2% from previous expectations.
    - Inflation projections increased by 0.1% to 1.3% in 2019 and were lowered by 0.1% to 1.4% for 2020.
- Retail Sales fell 0.4% m-o-m in April, largely due to a drop in online purchases.
- CPI headline inflation dropped in May to 1.2% from 1.7%.
- Markit Composite PMI increased to 51.8 in May from 51.5 in April.
- Markit Manufacturing contracted for a fourth month in May at 47.7. Global trade concerns, including Brexit and other geopolitical risks and weak demand within the auto sector, contributed to the data.
- German Markit Manufacturing dropped to 44.3 in May, the lowest level since 2012 and below the 44.4 reading in April. Manufacturing accounts for nearly a fifth of the economy. A decline in new orders coupled with a drop in employment drove the data.
Chinese Economy
- Caixin Manufacturing PMI slightly surprised to the upside in May coming in at 50.2 versus forecasts of 50.
- Caixin Services PMI fell to 52.7 in May, the slowest pace in three months. April’s reading came in at 54.5.
Canadian Economy
- Markit Manufacturing fell for the second consecutive month to 49.1 in May from 49.7 in April. Last month’s reading indicated the slowest pace in 3.5 years. Falling new orders on the back of declining trade conditions contributed to the data.
- Unemployment dropped to 5.4% last month, the lowest level since recording began in 1976.
U.K. Economy
- Markit PMI surprised to the upside in May with a reading of 51 compared to last month’s reading of 50.4 and expectations of 50.6 expected.
- Retail Sales dropped 2.7% y-o-y last month, the biggest drop in two decades, political and economic uncertainty on the back of Brexit drove the data.
- Markit Manufacturing fell to 49.4 from 53.1 in April, the lowest level since July 2016. Exports declined at the fastest pace since October 2014. Brexit uncertainty likely weighed on the data.
Reserve Bank of Australia lowered its key interest rate by 0.25% to 1.25%, the first rate cut in nearly three years. Weak global growth and intensified trade tensions partly prompted the bank’s actions.