Politics returns to haunt the markets - ING

Politics is set to come back into the spotlight in the next few weeks, with serious debates about economic reforms set to be addressed in many of the leading economies, which could also further complicate imminent policy decisions for the central banks, explains the analysis team at ING.

Key Quotes

“The European Central Bank is looking to follow the Federal Reserve’s lead in scaling back quantitative easing. However, the political pressure on it to do so is being countered by the upward pressure in the euro, which is hold backing inflation.”

“Seven months on from his inauguration and US President Trump is still searching for a major legislative “win”. Tax reform is now at the forefront of the Administration’s ambitions, but first, politicians will have to reach an agreement to raise the highly contentious debt ceiling. With only a matter a weeks to resolve this, and a bi-partisan deal needed, the prevention of a government shutdown is far from assured.” 

“But unless this political noise starts to spill over to the economy, sluggish inflation will continue to be the Federal Reserve’s major headache. We’re still confident that both core inflation and wage growth will make a comeback. But a lack of imminent progress could see an increasing number of Fed voters lower their rate hike expectations at the next meeting.”

“Low inflation is also making life tricky for the European Central Bank (ECB) as it tiptoes its way towards tapering, amidst increasing opposition to QE in Europe. We’re expecting President Draghi to extend quantitative easing by six months and halve the pace of purchases from January, although some technical tweaks will be needed. The recent surge in the euro is unlikely to stop the ECB in it its tracks, but a continued appreciation could conceivably see a more protracted path of ‘tapering’.”

“Almost a quarter of the two-year Brexit timeframe has now elapsed and there are still few signs of tangible progress. The contentious issue of the UK’s financial liabilities meant the third round of talks has ended in deadlock. The UK is keen to move onto trade talks, but the EU is currently unconvinced that “sufficient progress” has been made.”

“In China, a string of important reforms have set the scene ahead of a key Politburo meeting in the second half of the year. The yuan is also in focus, with the recent strength continuing to stem outflows. We expect the currency to stabilise around 6.60.”

“Things are looking up in Japan. The latest data suggests we might just be seeing the start of an upward trend in growth and inflation. But for now, Bank of Japan Governor Kuroda isn’t convinced and policy looks set to stay on hold for the foreseeable future.”

“A combination of EUR strength and USD weakness has briefly propelled EUR/USD above 1.20. Our expectation is that EUR/USD pauses for breath around this level. However, the risks remain skewed to the upside given that the bar is high for the ECB to delay its tapering decision. Additionally the ECB should also find some solace from lower bond yields and signs that external demand is strengthening.”

“It is never easy to focus on fair value for rates when digital risks like those emanating from N Korea are in play. But we think this dive for lower market rates should fade. But it’s not just about that; rates and Fed hike expectations have also been dampened due to low inflation. As US inflation edges higher, rate expectations should too.”