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ECB likely to dance on the Fed’s music – Deutsche Bank

FXStreet (Delhi) - David Folkerts-Landau, Group Chief Economist at Deutsche Bank, notes that the financial markets continue to be dominated by speculation over the timing of Fed rate hikes and concerns over the health of the global economy but, the Fed’s delay puts pressure on the ECB and BoJ to ease further and we now expect an extension of ECB QE in coming months.

Key Quotes

“Growth forecasts have been cut on the margin in recent months, reflecting lower expectations for the second half of the year in the US and a materially weaker outlook for Emerging Markets. The Fed’s focus on external risks in their decision not to hike in September stoked these concerns.”

“Despite these revisions, we don’t share the widespread pessimism. Domestic demand fundamentals remain solid in the US and Europe, and data in China are far from suggesting a sharp slowdown – leaving the world’s three largest economies on reasonably sound footing. EM growth remains a worry, but typical EM crises are unlikely given better external resilience (e.g., higher foreign reserves).”

“Risk assets have rallied in recent weeks as markets have pushed back the timing of the first Fed hike. The interplay between markets and the Fed actually presents a challenge: better data raise the odds of a Fed hike, tightening financial conditions and thus making a hike less likely. This circular interplay is not new however, and has not prevented the central bank from raising rates in the past.”

“But the Fed first needs confirmation that the US economy remains on track and that downside risks to China are limited – something we expect in the next few months. Only then can the Fed more credibly signal that rate hikes are coming, leading the market to price these hikes and limiting the scope of the likely initial adverse reaction. This is still possible by December, but the likelihood has diminished.”

“While a continuation of recent gains is possible, markets will remain volatile in the near-term as focus narrows on US and China macro data especially. Further clarity on the macro backdrop and path of monetary policy will be needed for the next leg up in risk assets.”

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