Market Insights – 9th of September 2019

Although his term as president of the European Central Bank (ECB) doesn’t officially end until 31 October, Mr Draghi is getting ready for one of the last encore in his career as a central banker this week. And his final bow comes at a crucial moment. The eurozone economy is running out of steam, and expectations for the ECB meeting are riding high. For the moment, the slowdown is most obvious in the manufacturing sector. Domestic consumer spending is holding up well thanks to the dip in unemployment and a slight rise in wages.

Lacklustre trade and the uncertainty caused by the US-China trade war are responsible for the manufacturing sector’s current woes. With Germany and Italy flirting with recession, Super Mario once again has a lot on his shoulders.

After several years of aggressive monetary stimulus, eurozone inflation is still at rock bottom. And if the current slowdown is too sharp, the worst nightmare of any central banker may come true.

In an industrialised world where structural debt levels are high and the population is shrinking, deflation is a much more dangerous threat than a possible return to soaring inflation, like we saw during the two oil crises. A further rate cut by the ECB therefore seems almost inevitable. But there is doubt about the effectiveness of negative interest rates, so Mr Draghi may decide to take more extensive measures. Just a few months after winding down the asset purchase programme, he may have to reverse course and reach back into his toolbox of unorthodox monetary policy. This may well be his farewell gesture before handing the reins over to Ms Lagarde, although she’s unlikely to stray too far from the course he has set.

Central banks around the world have long forgotten the dogma of days gone by and are likely to keep printing money. But as monetary policies prove less effective, it is probably time to bring in fiscal stimulus as well, especially in countries with a surplus to invest, like Germany. Christine Lagarde will soon take over responsibility for the euro, whose ongoing existence is owed in part to Draghi’s efforts at the most critical point in its history.

Although the trade war is still causing uncertainty, US economic fundamentals had some surprises in store last week. Manufacturing output once again declined in August, with the manufacturing ISM dropping below the 50 mark for the first time since 2016. Economists had expected output to level off, like in other regions of the world. But if the US economy is struggling, how is it that the stock markets are holding up so well?

The answer can be found in US consumers. Various indicators suggest that they are the ones keeping the US economy afloat, especially since capex has also retreated. With so much political and economic uncertainty, companies are finding it hard to think about growth and spending. Will companies also hold off on creating more jobs until they have more clarity about the outcome of the trade war?

Last Friday’s employment figures, which fell short of analysts’ expectations, suggest they might. While that may not hurt consumer confidence, it could well prompt the US Federal Reserve to cut rates for the second time this year at its meeting next week, which would prolong this period of expansion. The question is by how much: 25 basis points or 50?