Global Daily – ECB reluctant to buy short-end Bunds (for now)

by: Kim Liu , Maritza Cabezas

Euro Government bonds: ECB reluctant to buy short-end Bunds – The monthly QE purchasing data revealed that the ECB bought EUR 80.3bn in March, which is only slightly higher than the envisaged monthly QE target amount of EUR 80bn. This means that the cumulative frontloading (the amount which the ECB has bought more than it should have) remains stable at around EUR 5bn. As of April, the ECB will lower its monthly target from EUR 80bn to EUR 60bn. Today’s purchasing data was highly anticipated as the month of March was the second full month in which the ECB could buy bonds which yield below the deposit rate (currently set at -0.4bps). The ECB allowed these purchases as it otherwise would run into problems as there would not be enough (German) bonds to be bought whilst adhering to the 33% issue(r) limit. However, the data suggests that the Bundesbank did not delve into the short end yet. Including the month of March, the remaining weighted average maturity of  German bonds dropped from 7.88 to 7.65 years. Although the weighted average maturity of German bonds seems to be in a steady decline since December 2017, the fall is not extraordinary and less than anticipated. A possible explanation is that the ECB has stated (see here) that it tries to minimize purchases of bonds with yields below the deposit rate. This means that the ECB will first focus its purchases on bonds which yield above the deposit rate. However, despite these guidelines we still expect that the Bundesbank will be forced to skew more and more purchases towards the short end as it otherwise will breach the 33% issue limit rule for bonds with a yield above the deposit rate. We therefore expect that the weighted average maturity of German bonds will fall further in the coming months. Furthermore, the purchasing data shows that the ECB continues to lag its QE purchases as defined by the capital key for most notably Finnish, Irish and Portuguese bonds (cumulative lag of EUR 0.77bn, EUR2bn and EUR 7bn, respectively). According to our calculations we still expect that the ECB will need to pause its Portuguese bond purchases around May/June of this year, which is well before the prescheduled December end date of the QE programme. (Kim Liu)

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US Macro: Revising our US growth and inflation forecasts – As a result of the decision to pull the Republican bill to repeal Obamacare, we have become a bit more sceptical about the means to push through the tax reform. The Trump Administration’s ability to find the necessary support for passing future plans has been put in doubt. Moreover, there is already a delay in the budget resolution process for 2018. However, despite the delay and the uncertainty regarding the size of the tax cut, we think the US economy is resilient enough to deal with the muddle through. We have revised slightly downwards our GDP growth forecast for 2017 (2.3% yoy was 2.4%) and for 2018 . As for inflation, our forecast for headline inflation is now 2.5% (was 2.7%) in 2017 and is unchanged in 2018. We expect core PCE, the Fed’s preferred inflation measure, to move in the direction of the 2% target, during the second half of 2017. There are several factors that will likely reduce inflation pressures, including the still high labour underutilisation and profit margins. This means that the Fed will likely continue with a gradual pace of rate hikes. We still expect two additional rate hikes this  year and three rate hikes in 2018, instead of two as previously forecasted. This is because we still expect some stimulus to be implemented in 2018, which should lift inflation expectations in the longer run. (Maritza Cabezas)

Global bond yields: Changes to our eurozone and USD bond yield forecasts – Following the changes to our ECB base case scenario (see here) and to the US macro scenario (see above), we have modified our eurozone and USD bond yield forecasts accordingly. For the euro bond yields, we now forecast that the 10y German bond yield will climb to 1% and 1.4% at the end of 2017 and 2018, respectively. Previously, we expected both yields to be around 20bps lower. Crucial to our new eurozone base case scenario is that we now expect an earlier QE tapering (as of January 2018 a reduction by EUR 10bn a month) and that we expect the ECB to hike its deposit rate by 10bp in September 2018. Both events will lead to a repricing of the eurozone yield curve. The former should lead to increased volatility and upward pressure on German bond yields before the end of 2017 as the market will start to price in the QE exit. The latter should lead to a first step in the normalisation of euro money market rates, although we still do not expect the ECB to hike its refi rate in 2018. On balance, we expect the euro yield curve, most notably 2s5s and 5s10s, to steepen. We also judge that asset swap spreads will tighten over time. Finally, we think that an early QE tapering will put pressure on peripheral bond spreads. We expect that these spreads will widen further, with Italian bonds expected to underperform the most. For the US, we expect a reversal of the recent decline in the 10y Treasury yield. We expect renewed upward pressure on US yields on the back of rate hike expectations and higher eurozone bond yields. We see the 10y Treasury yield reaching 2.9% at the end of 2017. In 2018, we expect the 10y Treasury yield to peak at 3.2% after which it is forecast to gradually decline. Furthermore, we think that the peak in the 10y Treasury–Bund spread is already behind us. We expect this spread to steadily decline from currently 206bps to 190bps at year-end and to 140bps at the end of 2018. (Kim Liu)