ECB seen falling behind the Fed on growth risk


The Fed appears to be more worried than the ECB on downside risks to growth
Philip Wee, Eugene Leow07 Jun 2019
    Photo credit: AFP Photo


    FX: ECB is seen falling behind the Fed on growth risks

    The US dollar has been weighed down by Fed cut expectations. Tonight’s US monthly jobs report will be closely watched after Fed Chairman Powell opened the door for a contingent rate cut. Consensus expects US nonfarm payrolls to retreat to 175k in May from 263k in the previous month. Compared against ADP employment, which came in markedly lower at 27k, this seems a tad high. On the other hand, the employment sub-indices in the ISM surveys have been stronger in both the manufacturing and non-manufacturing sectors. Barring shocks here, the Fed will probably be patient and cut later in September, as evidenced by a more stable 10Y bond yield around 2.10%.

    The support for the USD Index (DXY) is currently located around its 200-day moving average around 96.5. The less dovish tone of the European Central Bank (ECB) at yesterday’s governing council failed to sustain the euro’s push above 1.13. The EU 10Y bond yield was uninspired by the marginal upgrades in the ECB staff forecasts and extended its decline to another record low of -0.24%. Real GDP growth for 2019 was revised up 1.2% from 1.1% three months earlier while those for CPI inflation inched up to 1.3 from 1.2%. Not surprisingly, the market has become nervous that the ECB has fallen behind the Fed in addressing growth risks.

    Rates: Fed easing bets get even more aggressive   
          
    Now that the Fed has opened the door for easing, market participants have become even more aggressive in betting on rate cuts. At the start of the year, an extended Fed pause was the most likely scenario after market turbulence in 4Q18. However, as China-US trade tensions escalate, the front of the curve now factors in four cuts by end-2020, 2-3 of which would be delivered this year. US data has not shown clear signs of weakening. To be sure, the ADP employment numbers (actual: 27k; consensus: 185k) are worrying and render tonight’s payrolls critical to watch. However, we should keep in mind that job numbers tend to be volatile. With the labour market already tight, job creation should slow. Jobless claims may be a better indicator of how the US economy is faring.

    The more worrying aspect lies with inflation expectations. Inflation expectations (as measured by the 10Y breakeven) fell to 1.77%, close to the bottom of its recent 1.7-2.2% trading range. Market volatility, trade war woes and the collapse in oil prices (WTI fell to USD 53/bbl from as high as USD 66 in April) are probably to blame. Headline and core inflation, which have been broadly holding up, could get dragged lower, the impact of higher tariffs notwithstanding. Clearly, while US data do not point to imminent rate cuts, forward looking indicators are painting a bleaker picture. Two Fed cuts (our base case) could well turn out to be insufficiently dovish if US data starts to weaken materially.       


    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com

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