In recent weeks, the actions and statements by various central banks left a marked impact across global financial markets including Malta. While only a few months ago, many economists and financial analysts were anticipating that the world’s major central banks were all heading for gradual monetary policy normalisation (gradually raising interest rates) after a long period of monetary stimulus policies, a new global cycle of interest rate cuts has started again.
At the beginning of June, the Australian central bank cut interest rates for the first time in three years, the central bank in India also followed with a rate cut and there are widespread expectations that the Bank of Japan will follow suit and increase its stimulus measures.
Moreover, the Chairman of the US Federal Reserve Jerome Powell recently argued that the central bank stood ready to cut rates and would “act as appropriate to sustain the expansion”.
The Federal Reserve is also under unprecedented political pressure with President Donald Trump repeatedly calling on the central bank to cut rates. Only a few days ago, the President criticized the Fed’s ‘very disruptive policy stance’. In fact, a leading international journal indicated that the US economists within Deutsche Bank now expect the Federal Reserve to cut interest rates three times during 2019 as a result of the trade tensions with China, weak inflation data and cautionary statements from the central bank.
After the last monetary policy meeting on June 6, the President of the European Central Bank (ECB) Mario Draghi also admitted that “several” ECB policymakers raised the possibility of renewed interest rate cuts. Despite the stronger-than expected start to 2019, Mr Draghi warned that “global headwinds continue to weigh on the euro area outlook”. The President explained that “the prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, is leaving its mark on economic sentiment”.
The ECB extended its forward guidance on interest rates by announcing on June 6 that interest rates will now remain “at their present levels at least through the first half of 2020” compared to the guidance earlier this year that interest rates will remain at present levels only until end-2019. Moreover, the ECB pledged that interest rates will remain low for “as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to two per cent, over the medium term”.
These latest statements came amid plunging inflation expectations. Underlying inflation declined to only 0.8 per cent in May and the closely-followed ‘five-year, five-year’ inflation swaps (gauging inflation expectations) dropped to just 1.2 per cent which is the lowest level in many years. Since oil prices have recently declined rapidly, the inflation rate is expected to decline once again in the months ahead.
Manufacturing activity across the eurozone is also suffering due to weaker global demand. Although the softer trend started to emerge since the start of 2018, the subdued dynamics of export-driven European manufacturing gathered more pace with the introduction of new emission standards in the auto sector in the second half of the year that were particularly detrimental to the strength of the German economy which is Europe’s powerhouse. Furthermore, besides increased uncertainties related to rising global protectionism, weak external demand for European manufacturing in recent months was also due to adverse changes to regulations in the auto sector in China, financial turbulence in emerging markets as well as the dramatic events related to Brexit.
Closely monitor the statements and actions by the major central banks since these often lead to significant changes across the capital markets
Amid this background, the ECB confirmed during its latest monetary policy meeting that it is determined to act in case of adverse contingencies and it also “stands ready to adjust all of its instruments, as appropriate, to ensure that inflation continues to move towards the Governing Council’s aim in a sustained manner”.
The statement made by the ECB that it will adjust ‘all of its instruments’ refers to the re-start of the bond buying programme which only came to an end in December 2018 after the acquisition of €2.6 trillion of eurozone bonds from early 2015 when the ECB claimed that it had accomplished its mission including countering deflation and staving off a deeper economic crisis.
Some international economists however claim that the ECB is “running short of monetary ammunition” and it is “finding it difficult to persuade investors that the slippage in inflation rates is anything but transitory”. In fact, some critics believe that another round of quantitative easing could be constrained by current rules stating that the ECB cannot own more than one-third of any country’s outstanding debt.
However, the Governor of the Bank of France, who is also a contender to replace the current Present of the ECB when his term comes to an end in October 2019, defended the recent decision by the ECB and claimed that the central bank could indeed intensify stimulus if the euro area shows more signs of weakness. On the other hand, he claimed that the ECB cannot resolve the trade tensions that are “the number one threat to the economy”. The French Governor argued that the onus is on political leaders, particularly US President Donald Trump, to end the trade tensions that are hurting confidence and growth around the world. He claimed that “today the danger is not a euro crisis ... there is a threat to the global economy”.
Following the recent announcement that the ECB pushed back its plans to lift interest rates until at least the end of the first half of 2020, together with the possibility of restarting the purchase of securities falling under the QE programme on increased fears over the health of the global economy, European bond yields continued to decline further into negative territory. The benchmark 10-year German Bund yield dropped to a new all-time low of minus 0.27 per cent last Friday thereby surpassing the previous low of minus 0.20 in 2016.
In line with these developments, various prices of Malta Government Stocks reached new all-time highs over recent weeks. For example, the indicative bid price of the 2.1 per cent MGS 2039 quoted by the Central Bank of Malta rallied to 112.73 per cent last Friday. This particular MGS had been launched in October 2016 at a price of 102.50 per cent at the time of the previous record level in MGS prices. The intense volatility in the price of this particular MGS since its initial offering in late 2016 shows the wide movements in bond markets from one period to another at a time of unprecedented monetary policy circumstances. After a brief rally during the first week of November 2016 to 106.15 per cent, the price of the 2.1 per cent MGS 2039 had slid to a low of 93.08 per cent in mid-March 2017 and only started trading close to the par value of 100 per cent in October 2017. It then touched the initial offering price of 102.50 per cent on various occasions and has been on a consistent upward trend during the course of 2019 as the political uncertainty and fears of the trade war left a marked impact on economic performance and bond yields across the world.
Following the shift in the interest rate cycle, market participants and investors must closely monitor the statements and actions by the major central banks since these often lead to significant changes across the capital markets which are also felt in Malta.
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