…They do not expect it.
More aggressive central bank action or lower central bank expectations: As we wrote about last Sunday, the market’s response to the ECB and Federal Reserve suggesting less accommodation than expected in July has been…to expect more. This creates a risky dynamic going forward. Central banks could deliver the amount of easing expected. They could deliver more easing than expected. But at the moment, this is not our expectation, with our forecasts for Fed and ECB rate cuts slightly less than current market expectations
Moreover, we’d stress that extra easing isn’tnecessarily a panacea: Surprise easing may boost markets,especially if coupled with an improvement in fundamental data. But we’d urge investors not to lose sight of the bigger picture. Investors became too comfortable in July with the idea that the Fed will do anything to avoid market volatility, which showed up in the correlation between stock and bond prices spiking to a 20-year high .We think we are back to the more common, negative relationship between stock and bond prices, with equity markets preferring a stronger growth environment to a weaker one.
We think this speaks to the power of growth to overwhelm central bank policy. Lower interest rates place more pressure on banks, reducing system stability. Note that European bank equities (SX7E index)have just made a new cycle low. US financial conditions are already easy, US growth is above potential (on our estimates) and core US CPI is now at 2.2%Y with a narrow output gap. All these factors complicate the case for aggressive central bank stimulus.