ECB cut increases possibility of LTRO, BlackRock’s Thiel says

Scott Thiel, Deputy Chief Investment Officer of Fundamental Fixed Income and head of the Global Fundamental Fixed Income Team at BlackRock, comments on the ECB and MPC announcements.

• In a move that surprised the markets, the European Central Bank (ECB) has cut the main refinancing rate by 25bps to 0.25%.

• The significance of this interest rate cut extends beyond the incremental stimulus that it provides to banks borrowing from the central bank. The ECB’s governing council has fortified the easing bias in its new forward guidance framework with policy action. Furthermore, in our view, yesterday’s interest rate cut increases the likelihood of a long-term refinancing operation (LTRO) in early 2014.

• In contrast, the Bank of England kept its monetary policy stance unchanged.

• Until yesterday’s surprise ECB move, fixed income markets had stabilised somewhat over the last month following the period of volatility around the US Federal Reserve (Fed)’s September meeting. Market consensus is now for the reduction or ‘tapering’ of its asset purchase programme to begin in March. We believe this presents further scope for volatility as the market continues to focus on US economic data and there is (an admittedly outside) risk that the Fed could reduce QE as early as December.

• Regardless of which month the Fed chooses to begin tapering, we are entering a new environment of monetary policy dispersion between the major central banks, with not only diverging policies but also different objectives. For us, this creates some very interesting investment opportunities.

• First the Fed, the world’s most influential central bank will, at some point in the next few months, start to reduce its asset purchase programme. In almost direct contrast, the Bank of Japan is just embarking on an unprecedented and massive QE programme aimed at stimulating the Japanese economy. Meanwhile, the ECB has an altogether different target, being largely concerned with reducing fragmentation within the eurozone. Finally, the Bank of England has a strong focus on the health of the nation’s banks and asset markets and is using forward guidance in an attempt to keep short-term rates low.

• We believe that at some point in the next few months the Fed will start to ‘taper’. We therefore retain our short duration bias in ‘risk-free’ rates on the view that yields in these bond markets will rise over the medium term.

• We remain supporters of peripheral European government bonds and actively trade our positions here based on both fundamental and strategic drivers. Currently we prefer to express our views via Portugal, Slovenia, Ireland and Italy. In addition, given our overall positive view of the eurozone, while cognisant that there are still many event risks out there, we retain our short Swiss franc position against the euro as safe haven flows continue to be unwound.

• Beyond the government bond space, we continue to like moving down the capital structure in stable sectors such as utilities. We also continue to favour certain subordinated European financials with a clear focus on capital and enhanced regulation.

• Another sector in which we are starting to see select opportunities is the external debt of emerging market sovereigns. Here we are finding idiosyncratic opportunities in the USD denominated debt of countries that have current account deficits and therefore need to adjust via rates and FX.

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