Warnings from major central banks

Article #595 by Edward Rizzo - Published Weekly

In recent weeks, the actions and statements by various central banks left a marked impact across global financial markets including Malta. While only a few months ago, many economists and financial analysts were anticipating that the world’s major central banks were all heading for gradual monetary policy normalisation (gradually raising interest rates) after a long period of monetary stimulus policies, a new global cycle of interest rate cuts has started again.

At the beginning of June, the Australian central bank cut interest rates for the first time in three years, the central bank in India also followed with a rate cut and there are widespread expectations that the Bank of Japan will follow suit and increase its stimulus measures.

Moreover, the Chairman of the US Federal Reserve Jerome Powell recently argued that the central bank stood ready to cut rates and would “act as appropriate to sustain the expansion”. The Federal Reserve is also under unprecedented political pressure with President Donald Trump repeatedly calling on the central bank to cut rates. Only a few days ago, the President criticized the Fed’s ‘very disruptive policy stance’. In fact, a leading international journal indicated that the US economists within Deutsche Bank now expect the Federal Reserve to cut interest rates three times during 2019 as a result of the trade tensions with China, weak inflation data and cautionary statements from the central bank.

After the last monetary policy meeting on 6 June, the President of the European Central Bank (ECB) Mario Draghi also admitted that “several” ECB policymakers raised the possibility of renewed interest rate cuts. Despite the stronger-than expected start to 2019, Mr Draghi warned that “global headwinds continue to weigh on the euro area outlook”. The President explained that “the prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, is leaving its mark on economic sentiment”.

The ECB extended its forward guidance on interest rates by announcing on 6 June that interest rates will now remain “at their present levels at least through the first half of 2020” compared to the guidance earlier this year that interest rates will remain at present levels only until end-2019. Moreover, the ECB pledged that interest rates will remain low for “as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to 2%, over the medium term”.

These latest statements came amid plunging inflation expectations. Underlying inflation declined to only 0.8% in May and the closely-followed ‘5-year 5-year’ inflation swaps (gauging inflation expectations) dropped to just 1.2% which is the lowest level in many years. Since oil prices have recently declined rapidly, the inflation rate is expected to decline once again in the months ahead.

Manufacturing activity across the eurozone is also suffering due to weaker global demand. Although the softer trend started to emerge since the start of 2018, the subdued dynamics of export-driven European manufacturing gathered more pace with the introduction of new emission standards in the auto sector in the second half of the year that were particularly detrimental to the strength of the Germany economy which is Europe’s powerhouse. Furthermore, besides increased uncertainties related to rising global protectionism, weak external demand for European manufacturing in recent months was also due to adverse changes to regulations in the auto sector in China, financial turbulence in emerging markets as well as the dramatic events related to Brexit.

Amid this background, the ECB confirmed during its latest monetary policy meeting that it is determined to act in case of adverse contingencies and it also “stands ready to adjust all of its instruments, as appropriate, to ensure that inflation continues to move towards the Governing Council’s aim in a sustained manner”.

The statement made by the ECB that it will adjust ‘all of its instruments’ refers to the re-start of the bond buying programme which only came to an end in December 2018 after the acquisition of €2.6 trillion of eurozone bonds from early 2015 when the ECB claimed that it had accomplished its mission including countering deflation and staving off a deeper economic crisis.

Some international economists however claim that the ECB is “running short of monetary ammunition” and it is “finding it difficult to persuade investors that the slippage in inflation rates is anything but transitory”. In fact, some critics believe that another round of quantitative easing could be constrained by current rules stating that the ECB cannot own more than one-third of any country’s outstanding debt.

However, the Governor of the Bank of France, who is also a contender to replace the current Present of the ECB when his term comes to an end in October 2019, defended the recent decision by the ECB and claimed that the central bank could indeed intensify stimulus if the euro area shows more signs of weakness. On the other hand, he claimed that the ECB cannot resolve the trade tensions that are “the number one threat to the economy”. The French Governor argued that the onus is on political leaders, particularly US President Donald Trump, to end the trade tensions that are hurting confidence and growth around the world. He claimed that “today the danger is not a euro crisis ... there is a threat to the global economy”.

Following the recent announcement that the ECB pushed back its plans to lift interest rates until at least the end of the first half of 2020, together with the possibility of restarting the purchase of securities falling under the QE programme on increased fears over the health of the global economy, European bond yields continued to decline further into negative territory. The benchmark 10-year German Bund yield dropped to a new all-time low of minus 0.27% last Friday thereby surpassing the previous low of minus 0.20 in 2016.

In line with these developments, various prices of Malta Government Stocks reached new all-time highs over recent weeks. For example, the indicative bid price of the 2.1% MGS 2039 quoted by the Central Bank of Malta rallied to 112.73% last Friday. This particular MGS had been launched in October 2016 at a price of 102.50% at the time of the previous record level in MGS prices. The intense volatility in the price of this particular MGS since its initial offering in late 2016 shows the wide movements in bond markets from one period to another at a time of unprecedented monetary policy circumstances. After a brief rally during the first week of November 2016 to 106.15%, the price of the 2.1% MGS 2039 had slid to a low of 93.08% in mid-March 2017 and only started trading close to the par value of 100% in October 2017. It then touched the initial offering price of 102.50% on various occasions and has been on a consistent upward trend during the course of 2019 as the political uncertainty and fears of the trade war left a marked impact on economic performance and bond yields across the world.

Following the shift in the interest rate cycle, market participants and investors must closely monitor the statements and actions by the major central banks since these often lead to significant changes across the capital markets which are also felt in Malta.

  Print This Page

The article contains public information only and is published solely for informational purposes. It should not be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in this article. Rizzo, Farrugia & Co. (Stockbrokers) Ltd (“Rizzo Farrugia”) is under no obligation to update or keep current the information contained herein. Since the buying and selling of securities by any person is dependent on that person’s financial situation and an assessment of the suitability and appropriateness of the proposed transaction, no person should act upon any recommendation in this article without first obtaining investment advice. Rizzo Farrugia, its directors, the author of this article, other employees or clients may have or have had interests in the securities referred to herein and may at any time make purchases and/or sales in them as principal or agent. Furthermore, Rizzo Farrugia may have or have had a relationship with or may provide or has provided other services of a corporate nature to companies herein mentioned. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security mentioned in this article. Neither Rizzo Farrugia, nor any of its directors or employees accepts any liability for any loss or damage arising out of the use of all or any part of this article. Additional information can be made available upon request from Rizzo, Farrugia & Co. (Stockbrokers) Ltd., Airways House, Fourth Floor, High Street, Sliema SLM 1551. Telephone: +356 2258 3000; Email: info@rizzofarrugia.com; Website: www.rizzofarrugia.com © 2021 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved. This article may not be reproduced or redistributed, in whole or in part, without the written permission of Rizzo Farrugia. Moreover, Rizzo Farrugia accepts no liability whatsoever for the actions of third parties in this respect.

This article was produced by Edward Rizzo, Director at Rizzo Farrugia, which is a company licensed to undertake investment services in Malta by the MFSA under the Investment Services Act, Cap. 370 of the Laws of Malta and a member of the Malta Stock Exchange. The company’s registered address is at Airways House, Fourth Floor, High Street, Sliema SLM 1551, Malta.