Global Daily – ECB-led steepening of curve in prospect

by: Kim Liu , Nick Kounis , Maritza Cabezas

Euro government bonds: ECB to scrap deposit rate floor leading to steeper curve – Due to ongoing uncertainty about Deutsche Bank, the 10 year Bund yield stayed underpinned at distressed levels of around -14bps. In addition, the difference between yields of 2 and 10 year bonds narrowed, meaning that there has been a further flattening of the yield curve. As investors focus on the impact of a possible Deutsche Bank fallout, the ECB’s bond scarcity dilemma has been temporarily overshadowed. However, we judge that this matter will regain a place in the limelight as we draw closer to the ECB’s Governing Council meetings of November and December. We expect that the ECB will announce at its December meeting a further recalibration of its self-imposed purchase rules and an extension of its programme by 6 months. We judge that the ECB will decide to drop the rule that it cannot buy bonds that yield below the deposit rate floor in order to increase the eligible universe of bonds it can purchase. This decision is the least controversial from a legal perspective and the most effective in freeing up bonds. If the ECB would decide to remove the floor, it will most likely lead to steepening of the yield curve. With regards to curve movements, we expect that the 2 to 5 year area will benefit from this decision and that it could even lead to a rise in 30y yields. (Kim Liu)

Global-Daily-Insight-29-September-2016.pdf (162 KB)

ECB view: Equity purchases unlikely any time soon – Debate about the ECB’s stimulus options have continued to rage, with an equity purchase plan mentioned as a possibility. We think the ECB could legally buy ETFs that fit its requirements, but it would be controversial and we question the benefits. An ETF programme could total EUR 200bn, which would not be large compared to the overall QE programme and assuming a market-weighted allocation, it would benefit the core more than the periphery. In addition, it is questionable whether it would have a major sustained impact on equity prices, economic growth and inflation, not least because equity wealth effects in the eurozone are modest. Based on ECB research, we estimate a 10% rise in equity prices boosts GDP growth by just 0.2% and inflation by 0.1-0.2%. In any case, it is questionable whether equity prices would get anywhere near that kind of support. Furthermore, the risk of losses is higher for equities than investment-grade credit. Ultimately, we do not think that the ECB will follow other central banks and turn to buying equities via ETF purchases any time soon, if at all. For a more detail, please see our note ECB Watch – Will the ECB buy equities? (Nick Kounis & Kim Liu)

US Macro: Capital goods shipments weak again, but strong orders suggest improvement in investment ahead – Core capital goods shipments, the data series used by the Bureau of Economic Analysis to estimate investment in durable equipment in the National Accounts, remained weak in August. They declined by 0.4% following a 0.7% fall in the previous month. They are down 5.1% 3mo3m annualised in August, which is a bigger fall than in Q2. The continuous weakness in business investment in the past quarters has been a drag (together with inventories) on GDP growth. This looks likely to continue in the near term. However, there is light at the end of the tunnel. The forward looking new orders of capital goods ex-defence and ex-aircraft rose by 0.6% after a 0.8% rise in July and are now up 1.9% 3mo3m annualised. This suggests business investment should firm in the coming quarters, and this is in line our base scenario. A weaker dollar should support exports and this will in turn be a positive for business investment, while an easing of the impact from the collapse in energy prices should also see the drag from investment in that sector easing. (Maritza Cabezas)