The international situation

The last ECB meeting marks probably a change in the European Central Bank policy. The relative inaction of Mario Draghi looked completely disconnected from past experiences when the ECB used to react to any revisions to the economic outlook.

The message from the Central bankers in Europe and Japan was: we cannot solve this problem only with monetary policy and we come to the limit of what we can do. Governments have to take their responsibilities and implement fiscal policy, not just monetary policy.

EQ program put in place is Europe and Japan and miles away to have reached their original target. Worst, the negative implication of such policy as started to hurt the real economy.

The purchases, along with low and negative interest rates are pushing more and more bond yields below zero, hurting the banking system and the pension industry that is already struggling to fund retirement plans. Instead of to invest in the economy, most of the sponsors will have no choice but to add more capital to their pension plans.

Eiopa’s first stress test of the industry in Europe, published earlier this year, showed that occupational pension fund assets were 24 percent short of liabilities, a deficit of 428 billion euros ($484 billion) even before applying a shock scenario.

In the UK, the Brexit has completely changed the situation. The long-term consequences for the economy have not been priced by the market but completely understood by Bank of England. The scale of measures to respond to a likely recession coming is impressive:
1. A 25 basis point cut in Bank Rate to 0.25%; 2. The purchase of up to £10 billion of the UK corporate bonds;
3. An expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion;
4. A new £100bn scheme to encourage banks to lend cheaply to UK companies.
It shows how BOE.
This is showing how BOE is concerned by the consequences of the Brexit.

The domestic situation

In the US, the situation is different. Whatever the quality of the growth, EQ program has been creating value bringing the unemployment rate level below 5%. Probably, the FED should start to increase interest rate long time ago. But international situation and weakness of domestic growth drivers pushed the FOMC in a different direction.

The FED is unlikely to increase interest rate at the 20-21 Meeting. Due to the US election, any movement is out of questions in October and November. So, “if all goes well”, they will increase the interest rate by 25bp in December. But again, I have my doubt. Investors have been waiting in vain for a significant increase in interest rate all 2015, and they will probably do again this year.

Economic conditions are too uncertain. In the first part of the year, the real annualised GDP growth has been below the growth potential at 1.2%. If a rebound is likely to materialise in the second part of the year due to more investment momentum, manufacturing recovery, and positive inventory impact, growth will remain limited close to 2%, below the US economy growth potential.

Job creation is still positive but it is not growing at the same pace than previously. In average, the US economy created 175K jobs over the past six months against 250K the same period before.

Finally, an increase in interest rate would be a shock for the FI and equity market, particularly in the emerging world. The recent rally is fragile and based only on liquidity driver, not on fundamental. Equity valuation is too high regarding the macroeconomic conditions and profit expectations.

With US election coming with the Trump enigma, uncertainty on the Brexit agenda and a dangerous referendum in Italy in November, I do not believe the FED will take the risk increasing interest rates.