CENTRALS BANKS TWEAK QE TO HELP PUSH UP MARKETS

Central bankers are back in the limelight as investors eye quantitative easing to prolong the market rally.

The Reserve Bank of Australia (RBA) was the first major bank to cut its rate by 25 basis points (bps) to 1.25% – its first easing since August 2016 after a similar campaign that stretched back to late 2011.

RBA Governor Philip Lowe noted that “it is not unreasonable to expect a lower cash rate” in the future, as the Australian dollar fell 0.82% against the US dollar in the first five months of 2019.

Days later, the Reserve Bank of India (RBI) cut both its repurchase rate and reverse repurchase rate also by 25 bps to 5.75% and 5.50%, respectively, while leaving its cash reserve ratio unchanged at 4.0%. It is the third consecutive interest rate cut since Shaktikanta Das assumed position as RBI governor last year. The Indian rupee has strengthened 0.5% against the US dollar in May.

The US economy remains strong and unemployment has fallen, but economists are worried about a prolonged trade war with China.

The US also threatened to derail a new version of the North American Free Trade Agreement (NAFTA) with Canada and Mexico over immigration issues on the US-Mexico border, but has now come to a deal.

The NAFTA deal has yet to be ratified by all three countries, but is already rattling their currencies. The Mexican peso fell 2.5% against the US dollar in May, while the Canadian dollar was down 0.37% during the same period.

“The risk is that the most recent US-China tariffs could further reduce investment, productivity, and growth,” said Christine Lagarde, director general of the International Monetary Fund (IMF), in June.

“Indeed, there is strong evidence that the United States, China, and the world economy are the losers from the current trade tensions,” Lagarde said. “We estimate that the recently announced and envisaged US-China tariffs could subtract about 0.3% from global GDP in 2020, with more than half of the impact stemming from business confidence effects and negative financial market sentiment.”

With Chinese data expected to worsen on the back of the trade tensions, the government is gradually rolling out measures to help the economy. In early June, the government said it would allow local government special bonds to be used as equity capital for some national projects.

Meanwhile, the People’s Bank of China has applied a stronger-than-expected countercyclical factor in the USD/CNY exchange rate, fixing it at 6.8930 versus expectations of above 6.90, and noted that it will issue bills in Hong Kong later this month to withdraw liquidity. Offshore Chinese yuan fell 2.7% against the greenback in May.

While, the European Central Bank kept key interest rates unchanged in June, it changed its forward guidance slightly, saying in its accompanying press release, that the governing council “now expects the key ECB interest rates to remain at their present levels at least through the first half of 2020”.

The six-month delay follows the three-month deferral announced in March. The announcement hardly surprised financial markets, though, as most are actually pricing in a rate cut as the next ECB move.

The euro is down 2.72% against the US dollar in the first five months of the year.

Investor confidence in the Eurozone has also tumbled as its economic outlook is again being threatened by increased trade tensions. The Sentix headline index dropped markedly in June to -3.3 from 5.3 in May, marking a halt to the recovery in confidence seen in recent months. Sentiment regarding the current situation has deteriorated slightly, but expectations plunged the most since mid-2016.

The Bank of Japan (BoJ) also aims to maintain current short- and long-term interest rates “at least until spring”. It has adopted measures to improve operational sustainability of its current policy framework. The BoJ’s own forecasts show inflation falling short of target even in fiscal year 2021. Meanwhile, the Japanese yen has gained 1.26% against the US dollar this year, given its status as a safe haven currency.

The British pound remains rudderless, down 0.5% against the US dollar as the United Kingdom looks for a new prime minister and addresses the key challenges of Brexit.