ECB View: Markets largely expect status quo over coming quarters – Financial markets have largely priced out further action from the ECB for later this year and are pricing in some chance of only modest additional stimulus in 2020. ECB-dated Eonia swaps suggest investors expect the central bank to remain on hold through the end of this year, while 3-month Euribor futures even price in somewhat higher rates. The latter most likely reflects expectations that the ECB’s tiering system (where around EUR 800bn of reserves will no longer be charged at the deposit rate) may put upward pressure on interbank rates. Meanwhile, Eonia swaps and Euribor futures are pricing in around a 60% chance of a 10bp cut in the deposit rate next year. The consensus of economists polled by Bloomberg also expect the deposit rate to remain unchanged this year, while one additional 10bp reduction in June of next year is expected. Meanwhile, that survey sees the ECB maintaining the pace of net asset purchases at EUR 20bn per month between now and the end of next year. We think that this is consistent with expectations priced into bond markets. Since August – the term premium (our own estimates) has fallen by around 15bp at the 10y maturity and 30bp at the 30y maturity. The term premium tends to capture shifts in market expectations about the outlook for the stock of securities held by the ECB. Indeed, in the weeks leading up to the September Governing Council meeting, expectations were for EUR30-EUR 40bn per month of purchases. Expectations were tempered by hawkish commentary in the immediate run up to the meeting and by the actual announcement itself.
Although market expectations are consistent with the ECB’s current views and guidance, we take a different view. In particular, we think that the ECB is too optimistic on the macro outlook as well as on the effects of its September stimulus package (see our preview for today’s meeting here). As such, we maintain the view that the ECB will cut its deposit rate by 10bp in December of this year before stepping up the pace of net asset purchases at the March meeting (to EUR 40bn a month from April). The combination of macro downgrades and additional ECB stimulus should fuel a renewed rally in government bond markets over the coming months. (Nick Kounis & Fouad Mehadi)
Fed View: OIS forwards suggest October cut a done deal, but question mark over December – All eyes are on the ECB for today’s Governing Council meeting (see above), after which the focus for markets will quickly shift to the Fed, with the October FOMC meeting due to conclude next Wednesday. We have long expected a 25bp cut at this meeting (see here), and although market pricing has fluctuated considerably in recent weeks, OIS forwards are now 90% priced for a 25bp cut. Given the lack of strong pushback from Fed officials prior to the blackout period, we think it is unlikely the Committee would spring a surprise on markets at this stage, and so an October cut is probably a done deal.
Could more resilient consumption put further rate cuts on the backburner? – The bigger question mark is over December, with OIS forwards pricing closer to 40% of an additional cut, down from 60-70% earlier in October. As a base case, we expect a further 25bp cut at this meeting. However, this view is predicated on weakness in the manufacturing sector feeding through to a slowdown in consumption. While we think the current strength in consumption is unsustainable (see here – second bullet), the resilience of consumer confidence in the face of slowing jobs growth suggests it may take somewhat longer than we expected for consumption to slow. With commentary from Fed officials sounding increasingly reluctant to ease – even more dovish members – this could well mean the December cut is pushed back to January, when a consumption slowdown becomes more visible in the data. (Bill Diviney)