DE30: The outlook for stocks and euro following the ECB meeting

Summary:

• ECB admits defeat and drastically changes the course of monetary policy
• European stocks don’t cheer the ECB’s decision as most of them trade lower
• DAX (DE30) pulls back just before the crucial technical resistance

Despite conventional wisdom that stock markets tend to cheer loose monetary policy, we have not got a confirmation of such thinking, at least not yet. This could stem from the fact that market participants could be more concerned about the deepening economic slowdown rather than focusing on lower for longer in terms of interest rates. On the other hand, gloomy moods seen across European stock markets could be also a by-product of what we saw in Asia with the Shanghai Composite tumbling over 4%. Let’s take a look what the European Central Bank did and what ramifications for markets might be.

After drawing the bearish candlestick several days ago, the German stock market failed to break higher. Instead, we have seen lower levels over the recent days. From a technical viewpoint one may expect that there is room for declines even toward 11000 points. Source: xStation5

The European Central Bank could not have disappointed markets by failing to deliver what had been already priced in - this could have seen the euro rallying. In fact, the ECB managed to beat expectations by taking the following steps. First of all, a series of new TLTRO programs will start this September and will last through the spring 2021. Having two year maturity TLTROs are designed to provide banks with cheap funding. However, as one may notice the borrowing costs for banks (the prevailing MRO rate) do not seem to be much higher compared to the costs banks have to incur when they decide to borrow money in the money market. Thus, one may doubt if the so-called cheap funding programs are enough to revive economic growth in the Eurozone. This is especially true when the problem concerns more a demand side rather than a supply side. In short, new TLTROs could be pointless when the companies’ and households’ demand for loans is low. Either way, any material effects coming from the series of new TLTROs are not expected to be at least until the end of the year. Furthermore, the ECB chose to alter the forward guidance saying that the interest rates will stay unchanged at least through the end of this year (earlier it had seen rates to be unchanged at least through the summer, thus the horizon has been pushed back by one quarter). Moreover, the central bank even discussed the possibility to extend forward guidance till March 2020 signaling that some members are unwilling to tighter monetary conditions even during the first half of 2020. This coupled with the substantial cuts of HICP and GDP projections for this year sent the euro much lower. Looking at the new path of HICP forecasts one may arrive at a conclusion that the ECB might find it extremely hard to strike the inflation target even until the end of the next year. Foreseeing inflation to be at 1.6% in 2021 is a clear signal of ECB’s dovishness.

The DAX (DE30) has begun Friday’s trading on the weak foot, most of stocks are falling. Source: Bloomberg

What is our take on markets following the ECB meeting? Although the economic slowdown is broadly expected to proceed, we think that the trough in terms of weakness of macroeconomic indicators may have been already reached. Thus, assuming a trade deal reached between the US and China could make the global economic outlook rosier in the second half of the year. Therefore, one cannot rule out a possible deposit rate hike in the Eurozone during the first six months of the next year. However, before this materializes the euro could become under pressure as the policy divergence with the Federal Reserve is expected to widen even more. This is based on the assumption that the Fed could deliver an interest rate hike in the third quarter. Nevertheless, having in mind that the US dollar is trading already quite high against the euro we do not see abundant space for the EURUSD to move lower. For stock markets the possibly improved economic backdrop could also be positive during the second half of 2019. Having said that, major stock markets are trading quite high therefore the potential for gains do not appear to be large.

Company news:

• BMW Group’s vehicle sales in February declined 4.1% YoY (BMW -4.7%, Mini -1.1%)