LONDON, June 18 — The euro took a beating and German bond yields hit a fresh record low today in reaction to European Central Bank President Mario Draghi’s comments indicating a possibility of new rate cuts or asset purchases.
Draghi said the ECB would need to ease policy again, if inflation did not head back to its targets, and that there was still “considerable headroom” to do so. Inflation in the euro zone slowed to 1.2 per cent in May, the lowest in more than a year.
German government bond yields, the benchmark for Europe, fell to -0.30 per cent for the first time ever and the euro slumped to a two-week low versus the dollar, while European stocks shook off early weaknesses to trade 0.9 per cent higher.
“From the market reaction, we are increasingly learning that when a central bank’s senior leaders vindicate expectations, market shifts extend. The same thing happened when the Fed confirmed its dovish shift earlier this year,” said Themos Fiotakis, head of FX and rates strategy at UBS.
Draghi, nicknamed “Super Mario”, looks set to end his eight-year term this year without having ever executed a rate rise.
The ECB’s signals came a day ahead of a widely anticipated US Federal Reserve policy decision, where expectations were running high that Draghi’s counterpart Jerome Powell would probably lay the groundwork for a rate cut later this year.
“In just a few months, the market has turned from being guided by the Fed to actively guiding the Fed,” interest rate strategists at Bank of America Merrill Lynch wrote.
The US central bank is likely to leave borrowing costs unchanged, but markets are almost fully pricing in a 25-basis-point rate cut for July.
The meeting will also provide the most direct insight yet into how deeply policymakers have been influenced by the US-China trade war.
Rate cut hopes, fuelled by Draghi’s dovish speech, led the US treasury yield to the lowest since September 2017.
Uncertainty over the trade war has sent investors storming towards US Treasuries, a Bank of America Merrill Lynch’s fund manager survey showed. Treasuries were the “most crowded” trade for the first time in its survey.
The impact of US restrictions on exports to China is already resonating in Europe with German silicon wafer maker Siltronic warning that the spat would hit its sales and profitability.
The warning knocked European technology stocks, but a sharp reversal in the euro and rate cut signals offset the weakness driving the pan-European STOXX index 0.9 per cent higher as of 1031 GMT.
In another blow to the German economy, which is expected to grow by just 0.5 per cent in 2019, a survey by ZEW institute showed the mood among German investors deteriorated sharply in June due to recent weak economic data and the escalating U.S.-China trade dispute.
In Asia, MSCI’s broadest index of Asia-Pacific shares outside Japan edged up 0.6 per cent, while Japan’s Nikkei dipped 0.7 per cent. MSCI’s gauge of stocks across the globe rose 0.15 per cent, boosted by Europe.
“Markets have been very tentative over the last few sessions, trading largely sideways...Oil dropping and gold rising is also an ominous sign,” said John Woolfitt at Atlantic Markets.
Crude oil slipped a further 0.8 per cent today on global growth worries, although losses were capped by tensions in the Middle East after last week’s tanker attacks.
Acting US Defence Secretary Patrick Shanahan announced yesterday the deployment of about 1,000 more troops to the Middle East for what he said were defensive purposes, citing concerns about a threat from Iran.
The dollar index, tracking the greenback against six major peers, is holding tight at two week highs.
The Australian dollar fell to a fresh five-month low of US$0.6830 after minutes from the Reserve Bank of Australia’s June meeting showed policymakers thought it might have to ease again to push down unemployment and revive wages and inflation.
The central bank cut rates to a record low of 1.25 per cent earlier this month to support the slowing economy.
Meanwhile, sterling steadied after hitting 5-1/2 month lows as traders waited for news on the contest for the leadership of the ruling Conservative party.
“The fact that Boris Johnson will most likely become the new prime minister hangs like a sword of Damocles over the trend of the pound. With this in mind, investors are currently rather reluctant to place too much trust in the currency,” said Marc-Andre Fongern, a strategist at MAF Global Forex in Frankfurt.
In the developing world, stocks were set to snap a four-day losing run today, while emerging markets currencies edged firmer against the dollar as cautious optimism crept into markets ahead of the Fed meeting. — Reuters
