Global Daily – ECB in wait and see mode

by: Nick Kounis , Shanawaz Bhimji , Nora Neuteboom

ECB Preview: Draghi to avoid shifts in market expectations – The ECB’s Governing Council meets on monetary policy this week. We do not expect any change in policy or language when it communicates its decisions and views on Thursday. We see the central bank as being essentially in ‘wait and see’ mode for now. This reflects, firstly, the weaker recent economic activity data. The ECB takes the view that this reflects a plateau for the cycle rather than a slowdown, but the soft numbers do create some uncertainty. Second, underlying inflationary pressures have remained weak and although the central bank expects them to pick-up, there remains also uncertainty about this. So the Governing Council may want to wait for more economic data and the June economic projections before taking a clearer stance on the direction of monetary policy going forward. Against this background, we think that President Mario Draghi will try to avoid shifting market expectations about the speed of the ECB’s exit one way or the other. That means sticking closely to the text that has already been communicated and batting away journalist questions on the outlook for monetary policy.

We think that the ECB will set out a clear roadmap for the end of its asset purchase programme in July. We expect a tapering period of 6 months (3 months EUR 20bn p/m and 3 months EUR 10bn p/m). We do not expect the first rate hike to follow until the second half of next year (10bp in September and another 10bp in December). We expect the ECB to maintain or even strengthen its forward guidance on interest rates when it announces a wind-down of net asset purchases. (Nick Kounis)

Euro Credit: Decline in CSPP likely a blip – The latest data from the ECB’s asset purchase program show a clear slowdown in the amount of purchases in April for corporate bonds, at least for far as the month goes. Net purchases amounted to around EUR 2bn month-to-date, which sits well below the numbers we’ve seen in the first three weeks of the prior months (March: EUR 4.3 bn, February: 3.8 bn and January: EUR 3bn). There has not been a commensurate drop in new issuance this month; 32 new deals priced so far versus 46 deals priced last month. Still, non-financial IG cash spreads showed resilience, with the cash index settling at 40bp asset swap. Credit investors, it seems, have not been spooked by the lower flow of corporate purchases from the Eurosystem central banks and assume that regular service will resume soon. We also judge that the lower CSPP net purchases represent a blip in the trend and expect purchases to move back to the levels seen in the previous months, at least until the end of September 2018, which is the period that the ECB has committed to the existing level of overall APP net purchases. The ECB has made it clear that it is planning to maintain the level of private sector purchases over this period and we see no reason for a change in strategy. (Shanawaz Bhimji)

Emerging Markets Macro: Turkey rate hike fails to stem lira weakness – The Turkish Central Bank surprised the market this afternoon with a bigger-than-expected rate hike of 75bp (ABN AMRO: 25bp, consensus: 50bp). The move has come amid increasing pressure on the lira, which has weakened some 7% year-to-date. While the currency initially recovered following the rate hike, it has since unwound those gains. Indeed, most EM assets have weakened in recent days as the US 10y Treasury yield breached the psychologically important 3% level, and expectations for Fed rate hikes increased. Turkey has been particularly vulnerable in this environment thanks to its relatively high current account deficit (around 6.2% of GDP), financed mainly by short-term portfolio flows (around 70%). Persistently high inflation (above 10%) has not helped either.

Despite these vulnerabilities, a near-term crisis in Turkey is not our base case scenario. The Fed’s rate hike cycle should remain gradual (one hike per quarter in our view), Turkey has a sound banking sector, and the dollarization of the real economy is higher than the official numbers may suggest. Moreover, in light the upcoming early Presidential elections (taking place 24 June), strong economic growth, fostered by government stimulus, will continue to attract investors looking for higher yields. However, we are not convinced that the government will address these increasing vulnerabilities successfully after the elections have taken place, and so the likelihood of a crisis-scenario increases going into 2019. (Nora Neuteboom)