Today QE came. The size and pace of the program is a positive surprise to us. The low risk-sharing and the TLTRO-tinkering are not. Despite Draghi’s stance, it actually does matter whether risk-sharing is 20% or 100%. In scenarios, Germany will perform on this. Violent moves in the market, especially on long yields and break-evens.
No discussion here is futile
The size and pace of the collective programme was in (modest) excess of market expectations, however the very low risk sharing number of 20% was disappointing to many, and certainly to us. Draghi downplayed the importance of this number, and highlighted the difference to the 2012 OMT-put. To us, if the potential losses really are hypothetical, then why don’t assume the full risk from the ECB. When they don’t, it’s a hard sell saying it doesn’t matter. This is not boosting the credibility of this package.
The TLTRO adjustment surprised us somewhat, in particular because it in our view is outright bad practice to those who – in good faith – entered the TLROs in September and December at what they assumed was a fixed price. A cheaper cost on its own heightens the prospective future take-up, but the outright lack of credibility may make some banks wary of what can happen next.
Market take – core rates
Core rates dropped massively on the QE-announcement in part due to the package being slightly larger and faster than anticipated but we think that the lack of risk sharing also adds to the bund-movement, down almost 15bps to 0.44%. Essentially, with just 20% risk sharing, in risk scenarios – if not now – it’s better to be in high credit countries than in lower credit ones. That seems obvious even if Draghi called the debate futile. Down the line, if credit spreads widen, more safe haven flows into German bonds is certainly possible.
On the short horizon with credit concerns low, the drops are close to identical for e.g. Italian bonds.
On swaps, instances after Draghi answered that they would buy between 2y and 30y maturities, investors scrambled for 30Y bonds, the 30Y EUR swap dropped 10 to 15bps instantaneously, though we’re seeing some rebounding now. This is notable as that completely erased the recent substantial increases to long end rates. This can underline the troubles for many market participants on very low long rates, which is not a desirable scenario.
Market take – money markets
The upside surprise to the package size have pushed down Eonia’s as more liquidity is being priced in. Draghi’s ninja-trick on the TLTROs also adds to the expectations here. Much of the curve is down 2-3bps and 9M3M has gone as low as -14bps. Risk/reward favors paying these levels in our view.
Market take – Fx
The ECB’s highlighting of the exchange rate being of particular focus underlines the importance of a weaker currency as a channel through which it hopes its open-ended QE program will work. The commitment shown by the ECB today strengthens the ECB’s guidance, which should prevent the EUR from appreciating much even if the Euro Area shows signs of improving growth, as we expect.
In relative terms, it makes sense for the EUR to continue to weaken below long-term averages. The situation is far from average. Indeed, in relative terms, the economic situation has probably never been this dire. In short, today’s decision should pave the way for a continued downtrend in the EUR/USD as long as the Fed remains on its exit track. At the end of the day, we expect the USD to remain the cleanest shirt in the laundry, even though the market’s confidence in the USD looks likely to be tested in coming months.
In the near term, we may see profit-taking as the QE smoke has finally cleared, but such EUR strength should be sold into.
Market take – inflation
Linkers included as was absolutely needed and also our base case. Especially the cash break-even markets have seen big increases over recent sessions. Now whether the true expectations really can rebound on this, naturally is too early to tell. The 5Y5Y inflation swap has rebounded massively to almost 1.75% (after having seen 1.50% earlier this month). The more immediate expectations – 2y2y – is above 1% at 1.02% with almost 30bps rebound today. Consequently, real rates are massively down on the front end of the Eur curve.
Nordea