At the time of writing, markets are still pricing in just under a 60 per cent chance that the ECB will raise interest rates one more time sometime in the coming months. And although Lagarde has only recently turned to wage growth as an argument for further tightening, there are plenty of reasons to at least pause.
The most recent reason is the Eurozone PMIs. Besides the fact that the Eurozone Manufacturing PMI has been moving to recession-like levels for months, now the services sector also seems to have succumbed. The Eurozone Services PMI fell below 50 for the first time this year, indicating contraction.
Now, while it is true that the PMI still has to fall a lot lower to speak of a solid recession and that the Services PMI may still show an erratic pattern from month to month, the signal is still predominantly negative.
Soft landing, right?
For those investors whose base case is the ‘soft landing’, it will at least take some swallowing. Not that the Eurozone economy will immediately fall off a cliff, but that is also not necessary to make things difficult for equity markets. Those are cheerfully assuming positive economic, but more importantly, earnings growth.
But, that will be harder than assumed, in my view, which means that the relatively attractive valuation of Eurozone equities, which moreover have fallen through their 200-day moving average, matters little yet.
Inflation cliff
In addition, the likelihood of rapidly falling inflation seems to be underestimated. If the historical relationship between German producer and consumer prices holds up at all, headline inflation in Germany should fall off a cliff. I know there are persistent deficits in the service sector and labour market, distorting the relationship, but with a bit of negative growth, inflation could nonetheless fall sharply.
Time for a break
Add to this the fact that we are now at or over the lead time required for series of interest rate hikes to have their impact on the economy, and it seems opportune for the ECB to bet on a pause for now. After that, I expect that procrastination will be a reprieve this time and we will have seen the last interest rate hike.
But Lagarde is stubborn and determined to restore the ECB’s credibility, insofar as this is still possible when you hold almost all Italian bonds issued in recent years, which could so easily lead to a traditional policy mistake.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Monday on Investment Officer L uxembourg.