A Dovish Taper? Markets React To ECB Announcement On Quantitative Easing

On the latest edition of Market Week in Review, Senior Quantitative Investment Strategy Analyst Kara Ng and Rob Cittadini, director, Americas institutional, discussed the European Central Bank's (ECB) recent statement on the future of its quantitative easing program.

ECB likely to close the books on quantitative easing at year's end

At a press conference following the ECB's June 14 policy meeting, President Mario Draghi announced that the central bank will likely conclude its bond-purchasing program, otherwise known as quantitative easing (QE), by the end of the year, Ng said. "The ECB plans to cut the pace of its asset purchases in half by the end of September - and then do away with the program all together by the end of December," she explained.

Draghi managed to pull off what's known as a dovish taper with his remarks, Ng said - announcing the tapering of QE while at the same time eliciting a dovish market response. "In the hours following his comments, European bond yields fell, the euro depreciated against the U.S. dollar and eurozone equities rallied (per the Euro STOXX 50® Index)," she stated.

While the announcement itself wasn't a big surprise to most - the ECB chief economist had hinted at an announcement on QE during comments the week of June 4 - the dovish forward guidance from the central bank was a bit unexpected, Ng said. In particular, a section within the statement released by the ECB noted that interest rates will likely remain unchanged until the end of summer 2019 at the earliest, she pointed out.

Fed hikes interest rates, upgrades economic growth forecast

Turning to the U.S., Ng said that the Federal Reserve's (the Fed) decision to raise interest rates at its June 13 meeting was reflective of the central bank's optimism and confidence about the U.S. economy. "Fed Chairman Jerome Powell noted that the nation's economy is in great shape - and added that, should conditions evolve as expected, the federal funds rate will likely rise to normal long-term levels in the next year or so," Ng said.

In Ng's opinion, the tone emanating from the Fed meeting was slightly hawkish, as indicated by the fact that the median Federal Open Market Committee (FOMC) member now expects a total of four rate hikes in 2018. "The Fed also made some upgrades to its inflation and growth forecasts, while downgrading its unemployment projections," she added.

U.S.-China trade dispute continues

Shifting to trade, Ng noted that U.S. President Donald Trump's June 15 announcement that the U.S. will slap 25% tariffs on up to $50 billion worth of Chinese goods means that a risk now exists for an outright trade war between the two nations. However, she stressed that in the opinion of her and the team of Russell Investments strategists, that's still not the most likely outcome. "Our central scenario is that there will be slow and choppy progress made in trade negotiations between the U.S. and China," Ng stated, adding that she believes the tariffs are most likely being used by the Trump administration as a negotiating strategy.

If the trade spat between the two countries does escalate further, there could be true damage, Ng said - with disruptions to supply chains, a fall in business confidence and a slowdown in economic growth. "This would be a negative for the stock market, and - were this to occur - our team of strategists would likely shift to underweight global equities," she said. Ng concluded by emphasizing that, in her opinion, a resolution on trade between the U.S. and China remains the leading scenario.


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