Morgan Stanley: Central Banks Poised to Keep the Expansion Rolling

Central Banks seem poised to do all in their power to keep the expansion rolling. The Global Fixed Income team shares their review of the first half of 2019 and their outlook for the second half.

29.07.2019 | 12:36 Uhr

What an extraordinary month June was. Virtually every financial asset generated a positive return. This is a very rare occurrence and even more extraordinary as it occurred with economic data deteriorating and disappointing across the globe. What gives? Central banks are what gives. The European Central Bank (ECB) and the U.S. Federal reserve (Fed) independently signaled their willingness to do a volte face and emphasize downside economic risks, significantly changing the likely direction of monetary policy. When it was hard to out-dove markets, these two central banks did it. And guess what? Financial markets loved it. Despite weak data, something credit and equities should not have liked, markets rallied. All of them, almost indiscriminately. Even the dollar took a tumble as risk premium vanished, as well as the U.S. yield advantage. By suggesting monetary easing was imminent BEFORE a recession hit (or was about to hit) these two central banks hit the sweet spot: what we mean by that is that their surprising dovishness did not panic markets (e.g., well, if the Fed is that worried maybe so should I). Instead, the cavalry was coming, in time to save the day.

We cannot emphasize enough the unusualness of this market performance. It is emblematic of a market unprepared for the cavalry to arrive and underinvested in everything. It also did not hurt that Presidents Trump and Xi managed to call a truce on their trade dispute. Now the hard part: The Fed and the ECB have to deliver. And, after they do, it has to work! Just because policy rates, yields and spreads go down doesn’t mean the economy must do better. This is not physics. What has to happen is that spending goes up. And this means companies have to reverse their declining investment plans and keep hiring, and consumers have to keep spending, and the trade war cannot heat up again, and we can’t have a hard Brexit. A long list. It is unclear how far yields and spreads will have to fall to trigger a stabilization and rebound in business confidence and spending. What we are sure about is that central banks, even if their policy tool box is getting threadbare, will go out guns blazing, meaning they will do all in their power to insure this expansion does not end this year or next. So far we agree with that prognosis given their abrupt change of mind.

Display 1: Asset Performance Year-To-Date9624876_Web_Display 1_v1

USD-based performance. Source: Thomson Reuters Datastream. Data as of June 30, 2019. The indexes are provided for illustrative purposes only and are not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See below for index definitions.

Quelle: Morgan Stanley

Display 2: Currency Monthly Changes Versus USD 9624876_Web_Display 2_v1

Source: Bloomberg. Data as of June 30, 2019. Note: Positive change means appreciation of the currency against the USD.

Quelle: Morgan Stanley

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