Pioneer responds to ECB QE update
Generally, we consider today’s announcement to be another small step in the right direction.
But undoubtedly the ECB (and particularly Draghi) have, probably for the first, under-delivered compared to what the market was expecting. We suspect that the hawks on the ECB council were reluctant to sanction further significant easing, given the relatively good economic data from the euro area region over the last six weeks. Another reason for the lack of further easing was probably the small revisions to ECB forecasts, with 2017 inflation only being revised down from 1.7% to 1.6%, whilst growth is being revised higher. There remains the option for the ECB to hint at further easing measures in weeks to come if the Euro continues to strengthen above 1.10 or if bond yields push significantly higher.
The lack of increase in the size of the purchase programme was disappointing for the market, and will put upward pressure on all Euro area bond yields, especially as the inclusion of regional and municipal bonds in the programme now means less purchases of sovereign bonds. As we have seen today already, we suspect the biggest losers will be the peripheral European bond markets like Italy and Spain, whose spreads were, in our opinion, already trading too tight to Germany given their economic fundamentals.
With the next ECB meeting not until late January, we suspect that core European bond yields may experience some upward pressure, especially as liquidity dries up in the run-in to the holiday period. Those markets where positioning is already extended, such as Germany, Italy and Spain will probably fare worst.
Our expectation is that credit spreads should remain in or around current levels, or even tighten further, with indices trading cheap to fundamentals. We are cautious about taking significant exposure due to the increasing idiosyncratic risk generated by individual names (cf Volkswagen and Glencore recently). We continue to believe that alpha generation from credit in early 2016 may come from sector and stock selection, and our credit analysts remain positive on their sectors. We remain overweight European Real Estate Investment Trusts (REIT’s), corporate hybrids and subordinated financials.
The Euro has already depreciated significantly over the last 12 months, and much is already priced in at current levels. With central bank divergence a growing theme in 2016, and our belief that the market is still not overly short the Euro, we expect some minor Euro weakness, but not a break of parity. We continue to favour the US Dollar against the Australian dollar, Korean Won, Chinese Renimbi and South African Rand, but our positions arte lower-than-normal due to year-end illiquidity and the forthcoming Fed meeting.
Overall, whilst we welcome today’s announcement, we believe that for the first time the ECB has underwhelmed with its announcements. Our view has been that the economic backdrop did not warrant further aggressive easing, but the market had got overly bullish and positioned accordingly. Perhaps now attention will begin to focus back again on the economic fundamentals, which in our opinion argue for higher core and peripheral yields. Another push for higher yields may well come from the US, where Federal Reserve Chairperson Janet Yellen last night appeared to signal a rate increase at the Federal Reserve’s forthcoming meeting on December 16th. However, it’s worth remembering that most central banks continually refine their QE programmes, so it wouldn’t be a surprise to see the ECB’s programme adjusted again or refined over the next 6-12 months.