China – Pre-emptive cuts.
This week, China’s PBOC surprised the market by cutting the required reserves requirement by 50bp to 12% (10% for smaller banks). The move is surprising as China displayed a robust recovery up to 1Q21, but data turned more wobbly in the past two months. The PBOC is thus acting very pre-emptively, taking little risk when it comes to the recovery. The question now becomes how deep an easing cycle can be. With the current set of data, a one-off signal should be enough, though the PBOC may act further if data continue to worsen. China 1Q real growth has been double digit, and even the most bearish estimates see 2021 well above 7% (with the government targeting 6%). CPI is lagging PPI but remains well above 9%. An intervention at such early stages of a potential slowdown is good news, in our view. It signals strong commitment to support activity, and removes tail risk for the global economy in 2H21. Easier China policy is likely to be of limited support for CGBs, given already tight level, but may help the currency weaker, especially as the Fed is about to turn more hawkish. Once initial concerns over growth have subsided, we see the change as positive for global risks and it removes downside from global growth.
ECB – Symmetric goal.
The ECB announced on Thursday results from its monetary policy strategy review. The main innovation is the introduction of a symmetric reaction function around the 2% inflation target. The twist is marginally dovish as downside deviations received a lower weight previously, but it was widely anticipated by markets. Moreover, the ECB pledged to gradually increasing owner-occupied housing in inflation, and to introduce climate change consideration into monetary policy implementation. Overall, the change is not dramatic and less impactful than what the Fed has the done. Chronically low inflation has been the main issue for the past decade already, and the ECB decided not to follow the Fed in the introduction of average inflation targeting, so that there won’t be a need to offset below-target inflation with higher prints. The climate change considerations are important, and will impact the shape of future purchases plans.
Markets – Growth choppiness.
This week, markets started being choppy, with equity volatility on the rise and some spread widening. The source of volatility has been growth and new concerns on the virus, with re-opening leading weakness and rates tightening on the move. The episode has been short lived for now, so it’s early to hunt for opportunities. Still, we would be wary of protracted growth scares and would consider marked weakness in re-opening sectors as an opportunity. The delta variant is spreading fast, but countries with high vaccination rates are not seeing an increase in hospitalisation, thus being able to push through with easing restrictions. On travel, high vaccination rates are pushing towards easing of rules more than delta variant cases are affecting restrictions. Also, Europe continues to be accelerating with vaccines and by the end of the summer will be close to US and UK. On a net basis, we think the delta variant will increase the number of cases but may end up not affecting the re-opening trade too much. We remain overall cautiously positioned due to the tight level of spreads, but see a few opportunities in re-opening sectors. We think rates and central banks hawkishness will eventually be a bigger risk for markets in 2H21.
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