Global Daily – Four scenarios for the ECB

by: Nick Kounis , Peter de Bruin

140403-Global_Daily_Insight.pdf ()
  •  Markets pricing in steady rates at today’s ECB meeting, but peripherals have rallied on eventual QE
  • No change is our base case, with rate cut the most likely alternative scenario
  • US ADP private employment report suggests that labour market is getting back on its feet

 Financial markets positioned for no change from the ECB

Financial markets appear to be positioned for no change in interest rates at today’s ECB meeting. Futures markets are pricing in broadly flat interbank rates through 2015, while Bund yields and the EUR/USD have retraced early falls on the view that the fall in inflation in March will not be sufficient to trigger policy easing. However, peripheral government bonds – especially Greece and Portugal – do appear to have benefited from Bundesbank President Weidmann’s new found openness to quantitative easing (though optimism on fundamentals have also continued to be an important driver of peripherals).

Base scenario: no change today – We think further monetary easing would be a great idea given the risk of deflation. However, the ECB’s communication is consistent with inaction and it had a great opportunity to move in March but did not. So we think that no change in policy rates and no new unconventional measures is most likely. In this case, we think the market impact will be limited unless Mr Draghi fails to sound sufficiently dovish in the press conference, which could push up rate expectations and the euro.

Most likely alternative scenario: mini deposit rate cut – The most likely alternative is a small cut (say 10bp) of both the refi rate and the deposit rate. EONIA and Euribor rates could then trend to around 0.1% and 0.2% respectively and the futures curves would shift down towards these levels. Government bonds would rally, especially the belly of the curve, and the EUR/USD would fall sharply.

Less likely: Liquidity measures – The stopping of the SMP sterilisation (or a more attractive LTRO) could push up excess liquidity and also depress short rates, short rate expectations and the euro. However, Mr Draghi seemed dismissive of this option in March.

Remote possibility: Asset purchase programme

The announcement of QE would boost risk appetite, push down rate expectations and government bond yields, especially in the periphery, as well as leading to a sharp fall in the euro. However, QE seems unlikely. If the ECB President sounds less than open to QE as a potential future option, this could hurt peripheral government bonds (likely temporarily).


US ADP private employment bounces back

US private employment was up by 191K, according to ADP. This was in line with the consensus forecast of a 195K increase in employment, though private employment growth in February was revised from 139K to 178K. As a result, job growth rebounded within the first quarter, from a 121K gain in January to a 191K increase in March. This is in line with our view that the labour market is slowly getting back on its feet after it was significantly impaired by the unseasonably adverse winter weather. Arguably, ADP’s report is the best singly indicator used to predict the official nonfarm payrolls series, which will be released this Friday. Indeed, although from month to month, ADP’s estimate of the labour market and the official nonfarm payrolls series may sometimes show a substantial deviation, since January of last year, ADP’s forecast have undershot the official labour market figures by just 9K, on average. While we are curious to see whether the employment sub-index in tomorrow’s ISM non-manufacturing index rebounded from its February dip, both the initial jobless claims series and ADP are now suggesting that the labour market is slowly strengthening again. As such, we see no reason to change our forecast for this Friday’s labour market report and continue to think that a 225K gain in nonfarm payrolls is within reach. Looking further into the future, we see the labour market recovery picking up further momentum as we are likely to see ongoing payback form the winter slump, while strong cyclical drivers will also come into play.