ECB President Mario Draghi still has the power to surprise markets.
Following the disappointment with what was delivered at the December 2015 meeting, some commentators felt that Draghi would struggle to meet market expectations today. But “Super Mario” delivered considerably more than the market was expecting. The old market adage of “Don’t fight the Fed” might now be changed to “Don’t fight Mario”.
There has been no “tiering” of the deposit rate, as was widely expected by markets and happened recently in Japan. Markets don’t seem too worried by this and on its own, could arguably be taken as a further headwind to bank earnings. Mr Draghi expanded on this point in his press conference, noting that the Governing Council had discussed the measure but felt that it was not currently needed.
However, and as an offset to the lack of “tiering”, the announcement of 4 new TLTRO’s at rates that could potentially be as low as the deposit rate should be a positive for the banking sector. Indeed, this TLTRO announcement could be the real surprise in this package of measures. We expect that the structuring of the TLTRO will be quite important, with banks who increase their lending being able to access funds at the deposit rate, but banks who don’t increase their lending may access funds at the refi rate, which is 40bps higher.
The ECB’s announced new staff forecasts for growth and inflation. For 2016, growth is expected to be 1.4%, it is forecasted to increase to 1.7% in 2017 and 1.8% in 2018. The ECB’s inflation forecasts were also changed and they now expect an average rate of 0.1% in 2016, 1.3% in 2017 and 1.6% in 2018. The inflation forecast for 2017 compares to the market’s expectation of 0.6%, so there is still a wide divergence between the ECB and the market. If the market is right, then the ECB will not meet its inflation target and may have to enact further easing measures. If the ECB is right, the current inflation breakeven levels looks to be quite attractive.
The reaction of the Euro is interesting. It appears that the currency markets were more impressed by Mr Draghi’s comment that rates are currently at the “lower bound”, rather than by his comment that rates will remain at, or lower than, current levels for a considerable period of time. We suspect Mr Draghi was attempting to halt on-going speculation about further rate cuts but as noted above, if inflation does not recover to the ECB’s forecasted levels, then the market will inevitably speculate about further easing measures.
Today’s clear winner was the European corporate bond market. We don’t know yet how much the corporate bond buying will be each month, but speculation is that it could be in the region of €5bn per month, or €60bn each year. This demand will act as a strong support for current spread levels and should see corporate bonds out-performing their sovereign counter-parts.
In an interesting side-effect of today’s price action, the appreciation of the Euro / depreciation of the USD represents a loosening of financial conditions for the US. As such, it might encourage the US Federal Reserve (FED) to increase interest rates at their June meeting. Why not at their March meeting? Because markets haven’t priced a rate rise in for March, and a surprise hike might upset markets and cause significant volatility.
Tanguy Le Saout is head of European Fixed Income at Pioneer Investments