- ECB President threw down the gauntlet for the Governing Council at Jackson Hole…
- …at today’s meeting we expect it to deliver a small asset purchase programme
- Large scale QE and further policy rate cuts are possible, but less likely
The heat is on
ECB President Mario Draghi put himself under some pressure to deliver extra stimulus today following his Jackson Hole speech. Below we look at various possible outcomes for the meeting, and the likely impact on markets.
Our base case is a small asset purchase programme (60%)
An ABS purchase programme looks like the minimum the ECB will announce. The market for ABS in the eurozone is relatively small at around EUR 970bn. Given this, it seems unlikely that the programme can be much larger than EUR 50 – 100bn. An alternative option, would be a programme consisting of a mix of ABS, European agency debt and possibly corporate bonds. Total outstanding SSA debt (issued by European level institutions) amounts to around EUR 550bn, while debt securities issued by non-financial companies amount to 1.1 trillion. Given this, it could be possible to launch a programme with a target of up to EUR 200bn. If the ECB would only announce an ABS programme, markets might be disappointed unless it strongly hints at more stimulus to come. The announcement of the somewhat larger programme would lead to a rally in government bonds, led by peripherals in the short to medium part of the curve. We would aim for steepening in 5-10s but also steepening in 10-30s. The euro would weaken.
Full-scale QE (20%)
The ECB defines QE as a large-scale and broad-based asset purchase programme. To emulate the Fed’s QE-2 programme in the eurozone context, purchases should amount to EUR 400 bn. In terms of scale, the easiest market for outright purchases would be government bonds. The central bank could use its capital key to divide the purchases between individual sovereign bonds. However, some officials would regard this (wrongly in our view) as blurring the lines between monetary and fiscal policy. The Bundesbank would lead the opposition. It might therefore be difficult to achieve a consensus around such a policy, unless the economic circumstances were to deteriorate more significantly. If the ECB decides to go out for a full scale QE approach, yields would go down in every asset class, with predominantly the belly to 7yrs of the curve profiting the most. Again, we would favour long credit (both peripherals and semi core), 5-10s steepeners and 10-30s steepeners. The euro would fall sharply.
Policy rate cut (15%)
A final option for the ECB would be to cut the refi rate by 10bp and move the deposit and marginal rate accordingly. However, the central bank’s communication over the last couple of months suggests that a rate cut is not on the cards. For instance, after the rate cut in June, Mr Draghi signalled that policy rates had reached a low. At the August meeting, he talked about ABS purchases and QE as possible options for further stimulus, but did not mention a rate cut. A rate cut would come as a surprise to the market and would bring yields down further. The effect would however be less pronounced and lasting than full scale QE programme. We would favour receiving the September 2014 ECB OIS as a rate cut would bring Eonia further into negative territory. Another opportunity would be to buy September Euribor futures. We would see some euro weakness, but not as much as with full-scale QE.
No action, or new information (5%)
Following the ECB President’s change in tone at Jackson Hole, the lack of any announcement about further monetary stimulus does not seem very likely. In this unlikely event, we would argue for short credit, short duration, short bunds or 10-30s flatteners. The euro would recover.