Daily Market Update: Decision Day for Draghi as markets await further Central Bank stimulus
We have seen some dramatic moves in financial markets following yesterday’s December meeting of the ECB’s Governing Council.
The Council decided on another package of monetary policy easing measures in order to support the outlook for growth and inflation, but what was unveiled yesterday fell way short of financial market expectations, in turn prompting major moves to the downside in the euro’s exchange rate as well as bond and equity prices.
Five measures were announced yesterday including: a 10bps cut in the ECB’s deposit rate (the main refi rate – the one to which tracker mortgages are linked ‐ was left unchanged, as expected); an extension of the QE programme to March 2017 from September 2016; the re‐investment of principal payments from asset purchases “as long as needed”; a broadening of the type of assets it will buy to include regional and local government bonds, and an extension of the favourable fixed‐rate full‐allotment bank liquidity regime at least until the end of 2017.
Ordinarily, such a package is certainly not to be sneezed at, as the associated stimulus is without doubt meaningful and helpful in underpinning growth and inflation prospects in the euro zone. However, the problematic issue is that yesterday’s announcement represented a major disappointment to markets which had developed extremely elevated expectations about what would be delivered by Draghi et al. In particular, markets had been priced for a larger depo rate cut, an increase in the monthly run‐rate of QE purchases and a longer extension of the planned timescale for QE. So when it became clear that Draghi’s 5‐point plan was failing to hit the very lofty expectations of market participants, the result was a pretty violent market reaction across a range of asset classes.
10‐year bond yields in many countries of the euro zone are this morning about 20bps higher than early yesterday, the Euro Stokxx 50 benchmark equity index has dropped 3.7%, while the euro was sold heavily and rapidly to leave it nursing losses of 2.8% and 1.6% over the past 24 hours against the dollar and sterling respectively (opening at $1.0880 and 72p respectively). To put some context around these moves, Bloomberg data indicate that yesterday’s ca. 3% surge in Eur/USD was the second largest single‐day move in the euro’s history. So the combination of a large disappointment relative to very high expectations and skewed trader positioning following the expectations‐fuelled moves of recent weeks triggered what were some truly violent moves across markets.
While there has been lots of post‐meeting commentary laying the blame for yesterday’s mishap at the door of Draghi and some of his colleagues, we think a portion of the blame also needs to be assigned to market participants. We do think that the ECB could and should have found a way to check market expectations as they got ramped ever higher in the run up to the meeting. But we also think the market is guilty of suspending disbelief to a degree in allowing itself to get so bulled up on the prospects for action given that the incoming news on the euro zone economy has been encouraging in some important respects. As we have noted several times in recent weeks, the latest news from the business surveys has shown reasonably positive momentum is being maintained in economic activity, thus calling into question the need for the uber‐aggressive easing which markets had come to expect.
In any case, whatever one’s view on the damage to ECB credibility arising from yesterday’s developments, the bottom line is that less stimulus than expected was delivered yesterday. And, barring any downside surprise on growth/inflation prospects, there wasn’t any major signal that further follow‐up action is particularly likely at this stage. Those observations imply somewhat less downward pressure on the euro on the exchanges relative to expectations in some quarters of the market landscape.
However, it is important not to forget that the ECB did ease policy materially yesterday, and that this easing is taking place against the backdrop of a highly likely upcoming tightening of monetary policy in the US (an expectation again supported by comments from Fed Chair Yellen yesterday). That is, while the theme of policy divergence suffered a blow yesterday, we do not regard that blow as fatal. We continue to think that Eur/USD is likely to come under some modest renewed downward pressure in the period ahead, and we continue to target sub $1.05 in the weeks and months ahead. However, yesterday’s developments leave us even more sceptical that the pair will see a sustained move below parity on that time horizon.
Looking to the day ahead, the last US payrolls report before the Fed’s December meeting is announced at lunchtime. Expectations are for a moderation in jobs growth from October’s exceptionally strong 271k to a still robust 200k in November, which would provide confirmation of further improvement in the labour market. We think that it would take a substantial downside surprise to deter the Fed from raising interest rates in December.
Should the release land in the ballpark of consensus expectations, in our view this would further underpin market expectations for a December rate hike and potentially provide support for higher US market interest rates and a stronger dollar. The US trade balance will also be released for October and is expected to print at a deficit of $40.5bn following a similar figure in September. Such a figure would be consistent with the drag from net exports on the headline GDP growth rate beginning to dissipate in the fourth quarter.
Finally, ECB president Mario Draghi gives a speech at the member’s meeting of the Economic Club in New York and several Fed members also speak today, namely Harker, Bullard, and Kocherlakota.