Anticipation Is Everything

It’s difficult to get past the obvious at the moment. Markets have made their bet on further monetary easing, and they’re now waiting for central banks to deliver.

Policymakers have been showering markets with promises to “act if needed,” and assurances from those stuck at the zero bound that the toolbox is far from empty. But they haven’t done anything yet, though this is a position that will be closely examined this week. Mr. Draghi will be at the spotlight first today when he delivers his introductory statement at the ECB forum in Sintra. The nebulous 5y/5y forward inflation gauge has crashed to new lows recently, and it seems to me that the consensus now expects a signal from Mr. Draghi that the ECB will cut its deposit rate, or re-start QE, as soon as September, which incidentally will be Mr. Draghi’s last meeting as ECB president.

Meanwhile at the Fed, the only question seems to be whether The FOMC cuts by 25 or 50 basis points in the next few months, setting the stage for an interesting June meeting this week. To the extent that markets have priced-in monetary easing in response to the deteriorating trade negotiations between the U.S. and China, it would make the most sense to assume that the much anticipated Osaka sit-down between Mr. Trump and Xi—at the end of June—to be a catalyst for something in markets.

I am fairly confident, how-ever, that investors are poised to run away with the narrative this week if messieurs Draghi and Powell provide even the slightest hint that the dam is cracking. Objectively, it would make sense for both the Fed and the ECB to lean against market expectations, but I can’t be sure that they will. The arc of the narrative is bending strongly to-wards the imperative for policymakers to do more, anything really, to ensure that the current expansion continues, whatever the costs in terms of capital misallocation and future inflation.

The mounting evidence of a shift in global monetary policy has reminded me of a tool that used to be a key tool in my kit of indicators; a diffusion index of global central bank rates, and bond yields. The idea is simple, when global short-term rates are rising, it tends to lead economic activity down by six-to-nine months, and vice versa when rates are falling. The two charts below try to put this idea to the test. The first shows that a six-month diffusion index of central bank rates points to a positive inflection point for global industrial production growth in the second half of the year, though it is worth noting that this framework doesn’t distinguish between unchanged and outright falling rates. The second chart tries to correct for this by showing a diffusion of global two-year yields. It also suggests that a bottom in global growth will form at some point in H2.This is good news for equity bulls—and potentially bad news for bond bulls—though the leading economic data only partially support this message. The best thing I can say about global real M1, and my in-house diffusion index of leading indices, is that they aren’t falling anymore, at least not as rapidly as at the start of the year. That said, neither of them were showing any convincing signs of rebounding at the start of Q2. Data for the domestic economies in Europe and in the U.S. have generally been solid, but most indicators for trade and manufacturing are still signalling downside risks to headline GDP growth.

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