Central banks’ dovish cooing keeps world stocks lulled near two-week highs

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The German share prize index (DAX) board is seen at the end of a trading day at the German stock exchange (Deutsche Boerse) in Frankfurt, Germany, 12 February - Reuters 

LONDON (Reuters): World stocks held near two-week highs yesterday as investors bet on a worldwide wave of central bank stimulus, with expectations building that the US and the euro zone may deliver interest rate cuts as early as July.

Markets have been fired up by European Central Bank President Mario Draghi’s Tuesday volte-face on policy easing. In one of the biggest policy reversals of his eight-year tenure, Draghi flagged more policy easing if inflation failed to pick up.

However, German and US bond yields which hit record lows and two-year lows respectively after the speech, inched higher to trade just off those levels. European shares too slipped off six-week highs, and Wall Street futures indicated a slightly weaker open.

Some of the trepidation is down to the US Federal Reserve’s ongoing meeting, with a decision due at 1800 GMT. It is widely expected to follow the lead of the European Central Bank and open the door to future rate cuts.

“It should be really clear to absolutely everyone that this is a monetary policy turning point... Those rate cut expectations have now shifted much closer,” said Commerzbank Currency and Emerging Markets Research Head Ulrich Leuchtmann.

“Of course the other question is: What is the Fed doing? If the Fed takes the fundamental risk of political pressure seriously, they cannot do anything today,” he said, noting that President Donald Trump’s strident calls for lower interest rates posed a dilemma for the Fed.

But market sentiment has been buoyed also by news that Trump will meet China’s Xi Jinping at the G20 summit this month, even though many doubt the two men can reach a breakthrough on ending their trade dispute.

MSCI’s global equity index rose 0.4%, adding to Tuesday’s 1% gain, as Asian shares excluding Japan followed the lead of their European and US counterparts to jump almost 2% – their biggest one-day rally since January. 

Tokyo and Shanghai too climbed almost 2% while Australia’s main bourse hit an 11-year high.

All eyes are now on the Fed, with Chairman Jerome Powell holding a news conference after the announcement.

Futures are almost fully priced for a quarter-point easing in July and imply more than 60 basis points of cuts by Christmas.

As for Europe, markets have almost fully priced a cut in September, though some analysts, such as those at Germany’s Commerzbank, now say rates will be cut in July, rather than in the last quarter of the year as they had predicted earlier.

ECB sources told Reuters Draghi had flagged his measures so strongly that other board members would be unable to disagree with him at their 25 July meeting.

Yet all the clamour for easing creates risks policymakers will disappoint.

“Market expectations for a dovish shift are nearly universal, the only question seems to be the degree,” Blake Gwinn, head of front-end rates at NatWest Markets, said, referring to the Fed.

“Markets will be looking for validation of this pricing,” he added. “We think this represents a fairly high bar for the Fed to deliver a dovish surprise.”

Sub-zero yields

BofA Merrill Lynch’s latest fund manager survey spoke volumes about the sea change in sentiment. It showed investors were dumping stocks and had upped bond allocations to nearly eight-year highs. They also had crowded into safe-haven US Treasury bonds and cash.

The prospect of more policy easing and worries for the growth outlook kept German yields close to the minus 0.33% record low hit on Tuesday, while Japanese yields sank to the lowest since August 2016 at -0.145%. Yields on the US 10-year note reached the lowest since September 2017 at 2.016%, a world away from the 3.25% top touched in November last year.

The fallout in currencies has been significantly less, mostly because it is hard for one to gain when all the major central banks are under pressure to ease.

The euro did pull back after Draghi’s comments, but at $ 1.118 it touched only a two-week low.

The dollar eased slightly on the yen to 108.3, but was flat versus a basket of currencies. The yuan touched three-week highs versus the dollar on the trade news.