27 OCT

2017

Fixed Income , Topics

The never-ending story

Last week, several ECB members have already prepared the market, on the key aspects of the coming ECB’s policy announcements. So, as widely expected, the Governing Council left the key ECB interest rates unchanged.

  • Main Refinancing: 0.00%
  • Deposit Facility: -0.40%
  • Marginal Lending Facility: 0.25%

The Governing Council expects ECB interest rates to remain at their present levels for an extended period of time and well past the horizon of the net asset purchases.

On the non-conventional side, the ECB decided to unwind its QE at a much slower pace than expected. Mr Draghi refrained from mentioning the “tapering” word, preferring, instead, to speak about a reduction in monthly purchases.

From January 2018, the net asset purchases are intended to continue:

  • Size: monthly pace of €30 billion (from the current pace of €60bn per month).
  • Duration: until the end of September 2018, or beyond, if necessary.
  • Breakdown: the composition of asset purchases was not discussed, but the ECB will continue to buy “sizeable” quantities of corporate bonds.
  • Reinvestment: The ECB will reinvest maturing debt for an extended period after QE in order to stabilize the Bank’s securities portfolio at a high level (around €2500bn) after the end of QE and to limit the pressure on the term premium.

Overall, all options remain on the table, keeping the door open to further measures, if necessary. Mr Draghi pointed out that the programme was open-ended and “will not stop suddenly”, so we could deduce a potential further extension beyond September 2018. 

Economic conditions and outlook remain broadly similar to those discussed at the last meeting.

Risks to the economy remain balanced and recent developments seem rather favourable. The evolution of core inflation is also more favourable, but its growth remains insufficient and well below ECB objectives. The decisions made by the Board of Governors reflect a heightened confidence in the ability to progressively reach an inflation goal of close to 2.00%.

What about the market reactions?
The more dovish-than-expected tone was supportive for sovereign bonds and the credit asset class. The iTraxx Main and Crossover traded 2bp and 3.5bp tighter respectively on the day. Bundyields fell by around 6.7bp after the close-of-business statement. On the FX side, the EUR/USD dropped, just after the announcement, by 0.43%, to close to 1.176.

What’s next?
In early 2018, the ECB will have to cope with scarcity, which is becoming a binding constraint in public-sector markets. The ECB will have be forced to either change its capital key or accentuate the purchase of corporate, in preference to sovereign, bonds.

Impact on our money-Market fund range

Liquidity & Rate

The increase (30 billion) in monthly purchases until September 2018 will increase the excess liquidity path. This programme purchase will have exceeded 2 600 bn € by the end of September 2018.

The money markets reacted only marginally to the continued abundant liquidity facilities. The 3-month Euribor remained persistently close to the -0.33% pivot point, while 12-month rates broke through the-0.18% threshold. 

All these measures will maintain the short-term rate at a very low or negative level for a long period of time, and put pressure on our benchmark (the Eonia). Indeed, due to the huge amount of liquidity for the extended period, the EONIA would stay at this level – of between -0.35% and -0.36% – with a lower volume for the coming year.

Conclusion

The ECB’s monetary policy will remain accommodative for as long as necessary, and forward guidance on rates unchanged.

This extension gives the ECB time to make further adjustments to the programme if the outlook becomes less, or more, favourable or if financial conditions become inconsistent or better, with further progress towards sustained adjustment in the path of inflation. Overall, all options remain on the table and adjustment could come. One thing is certain: no rate hikes are expected before 2019.

Our funds are geared in this direction to outperform our benchmark in such market conditions:

  • Overweight credit and search for more yielding issuers (with a minimum short-term rating of A2/P2);
  • Optimal duration allocation, with a neutral stance, to avoid rate volatility

By taking advantage of the rate overreaction, thanks to swap or Euribor future strategies (by reducing temporary our duration), we can capture market inefficiency.