ECB Rate Cut is Priced In
The first three days of May present global markets with critical economic data releases and central bank meetings. My May capital markets calendar “Sell What in May and Go Away” will be released in the next few days and breaks down each of those important events. However, one event that seems to be capturing money manager attention in recent days is a potential rate cut from the European Central Bank (ECB) on Thursday May 2.
Investors should expect that rate cut will occur, lowering the ECB main refinancing rate to 0.50% from its current 0.75%. Speculation of a rate cut has raised investor concern that a larger sell-off for the euro currency will unfold. A potential euro sell-off could be perceived to place at risk the major 2013 tailwind of yen weakness. Or, domestically, would the U.S. dollar rise uncomfortably as the anti-euro currency, thereby placing large U.S. export earnings at risk?
Based on the current evidence, I expect that neither of those concerns will become reality. The path for the U.S. dollar is higher but not in aggressive style that would be a headwind to exports. Measured against the yen, the ECB rate cut should be considered a minor monetary policy ease versus the “all in” easing policy of the Bank of Japan.
Therefore, in both the currency and credit markets, view this rate cut as already “priced in.” Figure 1.1 highlights how the last rate cut in July 2012 (1.00% to 0.75%) did temporarily weaken the euro; however, it proved to be a knee-jerk reaction and quickly reversed into year’s end.
The perspective investors should take on the rate cut centers around the fundamentals of the European economy and its impact on global money flows. This week the ECB’s quarterly lending survey (Figure 1.2) underscores how challenged lending conditions in Europe are for businesses and households, declining for the tenth consecutive month. I offer the opportunity therefore remains in U.S. financials as flows of capital will continue from Europe directly into those much stronger U.S. institutions.
ECB President Mario Draghi is taking the proper course of action to stimulate loan demand and attempt to create much needed inflation for the eurozone core and periphery. However, it will not change the prevailing 2013 flow of funds that continues to favor U.S. markets over Europe. Hopefully, it will stimulate a eurozone economy that remains in recession and is infecting economic conditions in Germany.
Figure 1.1 Euro Currency Price Action in the Wake of July 2012 Rate Cut
Figure 1.2 ECB Quarterly Lending to Businesses