Uh-Oh...Draghi"s Ammunition To Buy Italian Bonds Before The Election Is Less Than We Thought

Having successfully pulled off the announcement of the ECB’s “dovish taper” – where monthly bond purchases will be halved to Euro 30 billion from January 2018 – last month, a challenge for Mario Draghi in Q1 2018 has appeared on his radar. The ECB’s bond buying ammunition is slightly less than analysts thought and there is the small matter of the looming Italian election. The latter is likely to be held in March 2018, although it could take place as late as May. Veteran strategist, now Bloomberg columnist, Marcus Ashworth explains in "Italy"s Shrinking Safety Net".

One of Mario Draghi"s hands is being tied behind his back just as bond markets may need his help the most. Data released by the European Central Bank this week show the ECB president will have reduced scope to buy Italian bonds if markets start convulsing ahead of the country"s general election in the spring. From January, the ECB"s Quantitative Easing program will pare its monthly bond purchases by 50 percent to 30 billion euros ($35 billion). Draghi has sought to soften this so-called tapering by emphasizing how the ECB can reinvest maturing bonds to pick up the shortfall.

 

There"s a hitch -- the central bank said it intends only to reinvest proceeds from maturing bonds in debt of the same country. That leaves Draghi with only limited flexibility to use his buying power to the benefit of one country over another.

Monday"s release showed that proceeds from these maturing securities, which could then fund new purchases of Italian bonds is both less than expected and likely skewed until after the election. Ashworth provides us with the numbers.

Monday’s release showed that proceeds from these maturing securities which could then fund further purchases of government bonds, will only be about 8.5 billion euros, less than analyst expectations of as much as 12 billion euros. This means the pace of bond purchases under the QE program will fall by about a third from this year"s rate of 60 billion euros a month. The first quarter will be noticeably lighter in monthly redemptions compared with the rest of 2018. The big months for Italian redemptions won"t come until April and October.

This is inconvenient, especially as the ECB had already been “pushing the envelope” in terms of Italian purchases (and French), as Ashworth laments.

The ECB has already spent most of 2017 buying more Italian bonds than the capital key, a formula that determines how much of each nation"s debt the central bank can buy, would suggest. That variation is allowable - but it leaves little extra available slack to cut Italy.

Ashworth notes that the fragmented nature of Italian politics could lead to problems for the Italian bond market in the run up to the election. While the anti-Euro 5-Star is the largest party, its reluctance to form coalitions has significantly reduced its chances of forming the next government. While that’s a positive, Ashworth’s biggest concern is the reaction of the bond market if Silvio Berlusconi returns to, “or even near”, power. As we discussed in “Berlusconi: The Greatest Comeback Since Lazarus?” here, last Sunday’s Sicilian elections were seen as an important barometer for the upcoming national election and Silvio is on the comeback trail.

Nationally, the PD (center-left) is just behind 5-Star, which has 28% support. In the center-right bloc, Forza Italia and the anti-immigrant, Northern League, have 14% each, while the far-right Brothers of Italy have 5%. As media outlets emphasised, much of the Sicilian election campaign focused on the personalities of those involved, rather than the “big issues”, like the economy, jobs and immigration. Ironically, we suspect that Mr Berlusconi will revel in such a situation if it continues in the upcoming national election campaign. Besides cementing the alliance between his Forza Italia, Brothers of Italy and the Northern League, we will be watching as Berlusconi seeks to overturn the ban on his running for public office. Berlusconi, of course, denies any wrongdoing.

Super Mario (Draghi) has enjoyed a charmed existence as President of the ECB. There would be a comic irony if his legacy was tainted by his corrupt, octogenarian countryman so late in his tenure. As Ashworth concludes.

Draghi"s toolbox has been downsized. Investors can"t say they weren"t given fair warning. Their only consolation: his ability to pull a surprise at the very last moment.

What The ECB Will Announce This Week: A Summary Of All QE Tapering Scenarios

The main risk event in the coming week, in addition to a barrage of corporate earnings, will be the ECB"s long-awaited announcement of what the central bank"s QE tapering will look like. Conveniently, thanks to a trial balloon released on October 12, we already know the general parameters of this phasing out of monetization: ECB officials are considering cutting their monthly bond buying by at least half, from €60BN to €30BN, starting in January and keeping their program active for at least nine months, with some potential reference to a lengthening of the maturity of purchases.

According to a Bloomberg survey, the ECB will likely keep buying for about nine months to take the program to just over €2.5 trillion, respondents said before the ECB’s Oct. 26 decision. That’s consistent with what some officials see as the limit in the market under current rules. ECB President Mario Draghi is predicted to announce his first interest-rate increase in early 2019.

According to Bloomberg, "such an outcome for quantitative easing would soothe the concerns of policy makers who want a definite signal that the program will end, while giving succor to those who want to keep stimulus flowing as long as the inflation outlook remains lackluster. It doesn’t resolve the question of what happens in a year if consumer-price growth still isn’t on track to the ECB’s goal."

“There has been no dissenting voice at the ECB ahead of the meeting on the need to scale down net purchases,” said Maxime Sbaihi, an economist at Bloomberg in London. “So the question is less ‘if’ they will taper than the details of ‘how’ they will do it.”

Why not taper more? Simple: Mario Draghi is terrified of starting another bond (or stock) tantrum, if investors are spooked that the ECB is withdrawing too much support: "The Governing Council seems concerned that a more aggressive tapering plan could harm financial conditions, especially by letting the euro appreciate even more,” said Kristian Toedtmann, an economist at DekaBank in Frankfurt.

Meanwhile, the major sticking point among ECB governors appears to be whether to commit to an end-date for QE. Draghi has expressed confidence that the region’s economic recovery will eventually help him and his peers to deliver on their mandate. Yet inflation was 1.5% in September and ECB’s own forecast doesn’t see it returning to the goal of below but close to 2% before the end of 2019.

“It seems that the hawks want a definitive end-date while the doves want it open-ended,” Alan McQuaid, an economist at an economist at Merrion Capital in Dublin. “I think we will get a compromise, with the ECB saying that it intends to end its QE scheme in September 2018, but if things take a dramatic turn for the worse on the economic or inflation front in the meantime, it will extend its scheme further until things have stabilized.”

Which is why many model QE as lasting beyond the 9 month horizon, and running through the end of March 2019.

In terms of market consensus, the following Barclays chart visualizes the most likely outcome, showing monthly QE declining by 50% in January through October, when it tapers by another 50% until March 2019, coupled with a modest increase in the ECB"s deposit rate around the end of 2018.

But, as Bank of America asks, what if things don"t turn out that way? In the table below, the bank"s rates analyst Erjon Satko attempts to respond to the many questions the bank has gotten regarding possible market reactions to different decisions in terms of QE size/length but also to changes in the three technical aspects that matter in our view: the rates forward guidance, the maturity of QE purchases and the split between safe and risky assets (periphery, private assets).

Here are BofA"s observations on the various scenarios:

• In the €40bn/6m, we assume the ECB would leave the door open to a further extension, ruling out a cliff end (from €40bn to 0). That scenario, as well as the €30bn/12m would ultimately represent a large total QE amount. We thus assume that flexibility will be engineered with technical changes that should imply greater support for risky assets (this would be bullish the periphery and could also fuel a steepening in long-end swaps).


• In the €20bn/12m and even more so the €20bn/9m, the first market reaction should be bearish as the quantum of monthly Bund purchases is lower than expected. However, as previously discussed, we think the behavior of the periphery and risky assets in general will then guide term premium in Bunds. Hence the "then see periphery" in Table 1.


• Purchases skewed towards risky assets: For example, if the ECB hints to more limited tapering of private asset purchases relative to PSPP, or if it increases the share of EU supras, implying greater potential for deviations from capital keys, in favor of Italy and France.


• Extension of the maturity of purchases: the ECB could suggest that reinvestments will happen at a longer maturity than recent net purchases, or it could make more significant comments to signal longer overall purchases. As discussed last week, on way for the ECB to make this concrete could be that it drops the 30y maturity limit on eligible bonds

Yet despite the ECB"s tapering trial balloon, one surprising market reaction has been the recent decline in Bund yields together with the BTP spread tightening which according to BofA has "taken many by surprise, especially in light of the ever-decreasing expectations of QE support next year." In fact, while market expectations for 2018 ECB QE have been edging lower from €60bn/month to €40bn/month and now to €20-30bn/m, current valuations fail to give evidence of major concerns ahead of the tapering announcement. Of course, that may change once Draghi"s media jawboning becomes fact; alternatively this may simply be more evidence of what Citi"s Matt King provocative claimed this past summer, namely that the "market" has become so distorted by QE, it has lost the ability to discount the future.

* * *

In modeling market reaction scenarios to the ECB"s October 26 announcement, nobody anticipates a major market shock. In fact, some - such as Citi - expect various permutations of the QE tapering to be actually seen as dovish for the market. As we discussed last Saturday, Citi"s EONIA-signaling driven model seeks to predict the near-term market impact (around one-week) across the euro swap and Bund curve for a range of QE scenarios.

Below are its key findings:

• For 10yr Bunds, yields fall around 25bp in the most dovish scenario (€40bn x 12mth) and rise around 24bp in the most hawkish scenario (€20bn x 6mth). Figure 1 above summarizes the full set of results for Bunds.


• The most market neutral scenarios, according to the model, are €20bn x 12mth, €30bn x 9mth and €40bn x 6mth.


• This is broadly consistent with the Reuters poll (taken 11-14 September) which suggested the consensus amongst economists was for €40bn (range €30- 50bn) over 6mths (range 3-12mths).


• Cross-checking the model output (based on policy signals) with the total size of APP extension shows a clear relationship (Figure 2). The model therefore assumes that there is less of a role for the ‘intensity’ of purchases.


• The market neutral size for APP upsizing appears to be around +€250bn


• The Citi house view is for an extension in the form of an ‘envelope’ (without specifying a monthly purchase rate) of €150bn (with upside risk of €210bn). That could lead to a near-term sell-off of around 15-20bp.


• The scenarios presented assume deliverability. But, the most dovish options undoubtedly would be more challenging to implement (see below) given scarcity constraints. In terms of likelihood, we would put less weight on these scenarios which skews the risk towards a bearish reaction on 26 October.

Finally how should one trade the ECB announcement? Here Barclays" confusion reflects the (confused) trader"s mindset best: "we do not see compelling risk-reward in pre-positioning in EUR ahead of the ECB announcement, given shifting expectations and difficult in gauging how the market is pricing the parameter changes."

Translation: stop trying to pretend you know how the market will react to the ECB, and just wait for the announcement. Here"s hoping you are faster to react to the news than the HFTs.... and mind the direction of the initial kneejerk reaction, which is usually just the algos taking out all the stops.

How Will The ECB's QE Tapering Impact The Market? Here Are The Possible Scenarios

It was supposed to come with a "bang." Instead, the double trial balloon launched by the ECB on Thursday night, delivered at the same time by both Reuters and Bloomberg to make sure that everyone got it and according to which the ECB was considering slashing its QE in half from €60 billion to €30 billion and keeping the program active for at least 9 months, revealed one of the biggest market reaction "whimpers" to an ECB leak in years.

For those who missed it, here again are the bullets:

• ECB has consensus to extend asset purchases at lower volumes on Oct 26


• Agreed on reducing buys from €60 bln/month for nine months


• Debating buys between €25-40 bln - with a likely final bogey of €30 bln - and whether program should be open-ended

Perhaps the market reaction was unexpectedly muted because the announcement was i) largely in line with expectations and ii) still to be finalized. Naturally, the lack of an acute selloff in Bunds (and rates globally) was welcome news to the European central bank, for which another major bond tantrum would be the worst case scenario, one which could promptly unravel the entire carefully planned pre-tapering edifice.

The problem, however, is that the complete lack of a reaction failed to give Mario Draghi a sense of whether the €30 billion bogey was too high, too low or, maybe, just right.

Still, as Citi"s Harvinder Sian writes in a Friday note, the market impact from the ECB meeting is likely to be determined by the signaling channel for policy rates which is imbedded in the QE extension. In other words, the final framework of the ECB"s QE will certainly move markets, "although the purchase horizon is not the only variable that matters: the size of purchases will signal whether QE is most likely to come to a hard-stop or be open to continuation."

So what are the possible scenarios for the ECB to achieve it aim of tapering without tantrum, and via signaling. That will require a judgement on how the rates market will react to the new calibration of size and horizon, of which there are many options.

To answer that question, Citi take a look at the market impact from the various ECB policy permutations.

The starting point is that rates do not rise until ‘well past’ the net asset purchase period. The purchase horizon, however, is not the only variable to assess because a hard-stop at €20bn is easier to envisage than a hard-stop on a €40bn announcement. We look through these size/horizon combinations and model the EONIA curve for timing of the first rate hike, time to zero rates and the average hike per meeting thereafter. That is the framework for assessing euro swaps and Bund impacts. The bullish to bearish scenarios for 10yr Bunds range from -25bp to +24bp (one-week impacts) from current levels. The market neutral level of APP extension appears to be around +€250bn.

Or, just under €30 billion over 9 months, precisely what Reuters and BBG "leaked."

Below, Citi presents its EONIA-signaling driven model which aims to judge the near-term market impact (around one-week) across the euro swap and Bund curve for a range of QE scenarios.

Below are its key findings:

• For 10yr Bunds, yields fall around 25bp in the most dovish scenario (€40bn x 12mth) and rise around 24bp in the most hawkish scenario (€20bn x 6mth). Figure 1 above summarizes the full set of results for Bunds.


• The most market neutral scenarios, according to the model, are €20bn x 12mth, €30bn x 9mth and €40bn x 6mth.


• This is broadly consistent with the Reuters poll (taken 11-14 September) which suggested the consensus amongst economists was for €40bn (range €30- 50bn) over 6mths (range 3-12mths).


• Cross-checking the model output (based on policy signals) with the total size of APP extension shows a clear relationship (Figure 2). The model therefore assumes that there is less of a role for the ‘intensity’ of purchases.


• The market neutral size for APP upsizing appears to be around +€250bn


• The Citi house view is for an extension in the form of an ‘envelope’ (without specifying a monthly purchase rate) of €150bn (with upside risk of €210bn). That could lead to a near-term sell-off of around 15-20bp.


• The scenarios presented assume deliverability. But, the most dovish options undoubtedly would be more challenging to implement (see below) given scarcity constraints. In terms of likelihood, we would put less weight on these scenarios which skews the risk towards a bearish reaction on 26 October.

Is Every scenario as plausible?

The scenarios covered above include the four cited in the ECB sources story following the September ECB meeting (€20bn x 6mth, €20bn x 9mth, €40bn x 6mth, €40bn x 9mth).

The maximum implied extension of the four is +€360bn, which presumably is seen as achievable if it is on the table as an option. But, that would seem a stretch given existing scarcity constraints on Bunds and the extra challenge presented by reinvestments, which will grow to around €3.2bn/month for Bunds in Q4 2018.

The Citi scenarios include an even more dovish scenario which totals +€480bn. This really does seem to be pushing it. But, the ECB has proven to be resourceful in ‘using the full flexibility of programme’.

That said, there are various technical adjustments that could be deployed:

• The QE rules could change (again), such as allowing purchases below 1yr maturity.


• The composition of overall APP could also be altered. By that, we mean that the bulk of the reduction in purchases falls in PSPP. Note this would not mean an increase in the nominal purchase amount of CBPP3 and CSPP. Rather, that could be left unchanged allowing them to take up a greater share of a smaller overall APP (Figure 8 and Figure 9). There are challenges in these markets too, in terms of sourcing paper, especially with re-investments growing in CBPP, but new issuance may allow purchases to continue at around the same pace. The legal limits are also further away with the ECB estimated to hold around 40% of the covered bond universe vs a legal limit of 70%.

• Another option within PSPP is for some of the Bund share to be substituted for supras (ECB probably hold around 35-40% vs the limit of 50%).


• A greater portion could also be directed to agencies and regional debt.


• Deviations from the capital key could also be stretched further, though a complete disregard of the capital key is unlikely.

A long extension at €40bn/month, if deemed necessary from a macro perspective, is not easy to implement, but might be possible at a stretch. Perhaps this is why recent ECB speak (Praet, Smets) has been pointing to a more plausible lower-for-longer.

* * *

Citi"s conclusion is that the market risk, as of this moment, appears tilted to the bearish side. And even as the ECB looks to their models for QE calibration to meet the inflation target, ultimately the decision will be a compromise.

• The hawks will argue that deflation risk has disappeared, the benefits of QE are diminishing, the growth backdrop has improved significantly, and that financial stability risks are on the rise.


• The doves will point out that core inflation is not yet sustainable, wages are still low against the backdrop of a persistent inflation undershoot, and the euro has strengthened 12% since April.

The compromise reached is likely to respect the ECB’s demonstrated mantra of slow and steady policy withdrawal (a.k.a confident, persistent, patient, and prudent). The aim is a taper without tantrum. Anything else would risk a premature tightening in financial conditions.

Citi"s analysis shows that a super-dovish extension could drive 10yr Bund yields back down by 25bp to around 0.20% (close to the year-to-date lows). A super-hawkish extension could push 10yr Bund yields back up by close to 25bp to 0.70% (not seen since 2015).

Neither seems most probable. Emboldened hawks and implementation problems act against the dovish end of the spectrum while the desire to avoid a tantrum – especially if the euro rises again into the meeting – argues against the most hawkish scenario.

• If the middle ground seems most likely then the model indicates that a total extension worth around +€250bn or so is needed to avoid higher Bund yields. That can be achieved in various versions of a taper - €20bn x 12mth, €30bn x 9mth and €40bn x 6mth, with the shorter horizons and larger sizes leaving the scope for further extension on the table. This is where we think the consensus expectation sits.


• The risks are however skewed towards higher yields and bear-steepening, in Citi"s view. That’s because issuer limit constraints, which are probably a pivotal factor in recent ECB communication of lower sizes for longer, suggest more forcefully that the next QE extension should be more clearly interpreted as the last in this cycle.


• It is not hard to see the ECB take up the longer 9mth extension at a net €20bn, as discussed already at the September meeting. This could also be presented as 9mth x gross €30-35bn (including re-investments). That would lift 10yr Bunds towards 0.60%

Citi"s trade advice: "We continue to like steepeners, long USD rates versus EUR and are waiting for levels in 10yr Bunds near 0.65% and will then buy on expectation of a year-end squeeze as the ECB  purchase operations have to chase higher duration Bund holdings."

ECB Reportedly Considering Slashing QE In Half In January, EURUSD Shrugs

Mario Draghi"s "leaks" have lost their mojo.

ECB officials are considering cutting their monthly bond buying by at least half starting in January and keeping their program active for at least nine months, according to Bloomberg which cites "officials familiar with the debate".

Reducing quantitative easing to 30 billion euros ($36 billion) a month from the current pace of 60 billion euros is a feasible option, said the officials, who asked not to be identified because the deliberations are private. While the central bank’s governors are split on the need to identify an end date for purchases, a pledge to keep buying bonds until September -- with the proviso that it could be extended if needed -- may offer grounds for compromise, they said.

Policy makers led by President Mario Draghi are becoming increasingly confident that ECB policy makers will on Oct. 26 agree to the specifics of how much debt the euro-area’s central banks will buy in the coming year. After more than 2 1/2 years of trying to revive the region’s economy through bond purchases, some governors see the recent period of robust growth as a reason to rein in the support. Others are concerned that inflation remains too weak.

Separately, the ECB"s trial balloon sources must have been working in overdrive because the central bank"s favorite media outlet, the FX trading desk also known as Reuters, just blasted a similar report according to which "ECB policymakers are in broad agreement to prolong asset purchases at a lower volume at their October meeting with views converging on a nine months extension."

The details:

• ECB has consensus to extend asset purchases at lower volumes on Oct 26


• Agreed on reducing buys from €60 bln/month for nine months


• Debating buys between €25-40 bln, whether programme should be open-ended


• Reuters sources say no formal proposals made yet


• €25BN would be on the lower side of expectations


• Draghi defended pledge to keep rates low well past QE Thurs

EURUSD dipped a whole 15 pips on the headlines... then rallied it all back.

Typically this kind of leak is a strawman aimed at testing the market"s response in an effort to gauge just how ready traders are to accept the punchbowl being removed.

In this case the now-blinkered traders in FX land seem to have either lost all confidence in these leaks, or all belief that Draghi can ever pull out without immediately piling back in at the first sign of weakness.

#FedGibberish!

Authored by 720Global"s Michael Lebowitz via RealInvestmentAdvice.com,

Recently on our Twitter feed, @michaellebowitz, we introduced the hashtag #fedgibberish.

The purpose was to tag Federal Reserve members’ comments that highlight desperate efforts to rationalize their inane monetary policy in the post-financial crisis era. This past week there were two quotes by Fed members and one by the head of the European Central Bank (ECB) which were highly deserving of the tag. We present them below, with commentary, to help you understand the predicament the Fed and other central banks face.

Lael Brainard

On September 5, 2017 Fed Governor Lael Brainard stated the following in a speech at the Economic Club of New York:

“We should be cautious about tightening policy further until we are confident inflation is on track to achieve our target.” – “There is a high premium on guiding inflation back up to target so as to retain space to buffer adverse shocks with conventional policy.”

Let us rephrase: The Fed must be careful not to raise interest rates further until signs of inflation appear. When said inflation does pick up and it meets our target, we can then raise interest rates further. In doing so, we will then have the ability to lower interest rates when the economy hits a rough spot.

Inflation has been benign since the 2008 financial crisis. Clearly, nine years of the lowest interest rates on record have not been inflationary for the prices of goods and services that make up most standard economic inflation gauges. In fact, it is difficult to find a better real world example of deflation than the incoherence of negative interest rates manufactured by some central bankers who are begging for inflation. That said, there is a strong positive correlation between the amount of Fed stimulus and the price of financial assets. What Lael Brainard and her colleagues fail to understand is that excessive Fed policy has diverted capital away from productive investments that would generate the inflation and economic growth she and her colleagues so desperately seek to conjure. The bottom line is they do not understand the effect that eight years of excessive stimulus have had on the economy and are clearly unaware of what must be done to solve the global economic malaise.

Neel Kashkari

On September 6, 2017 Neel Kashkari from the Minneapolis Fed stated the following:

“Fed rate hikes may have done real harm to the economy.”

Kashkari senses economic weakness, which he believes is occurring as a result of the Federal Funds rate increasing from zero to 1.25% over the past 21 months. While that statement might be legitimately arguable, he is woefully negligent in helping his listeners understand why the economy is struggling despite the lowest rates in recorded history. An economy that cannot handle such a rise in the cost of money is symptomatic of a society burdened by too much debt. We posit that the economic problems the Fed aims to fix are the result of abnormally low interest rates and other stimulus of years past. These have not had the desired economic effects and have also curtailed future growth. After all, the use of debt pulls forward future consumption leaving less consumption in the future. Mr. Kashkari should consider that encouraging more debt is not the way to solve a debt burden. Either that, or he should let us in on his plan to forestall the arrival of the future from which consumption has been borrowed and payback is required.

Mario Draghi

On September 7, 2017 ECB President Mario Draghi stated:

“We do not see negative effects of QE”.

We are speechless. We simply ask Mr. Draghi – if there are no negative effects of QE then why are you contemplating tapering QE? In fact, why are the European people not rioting with pitchforks for a lot more QE?

There is no doubt in our mind Draghi’s statement flat out lie will become obvious over time. Until the media and the markets awaken from their central bank induced slumber, we leave you with the infamous words of prior ECB President Jean-Claude Junker:

“When it becomes serious, you have to lie.”

As we put the finishing touches on this commentary, New York Federal Reserve President Bill Dudley pointed out that the longer-run effects of disasters like the recent hurricanes actually lifts economic activity. Our reply to this absurd comment is simple: #fedgibberish

ECB Preview: A Trapped Mario Draghi Makes A Decision

After a barrage of media trial balloons (as recently as today) meant to temper the enthusiasm of Euro bulls now that the EURUSD is back to 1.20 and threatening European corporate profitability, Mario Draghi"s Sintra hawkishness is a distant memory.

And so, with the ECB"s policy decision less than 12 hours from now, a "trapped" Mario Draghi finds himself in a quandary: with less than 4 month left until the formal expiration of the ECB"s €2.3 trillion QE program, he will likely start laying the groundwork for the central bank"s stimulus reduction - after all the ECB is rapidly running out of bonds to purchase - but without revealing too much as that will send the EUR surging, and he will also hold off on any major commitment, as an explicit backing off his recent hawkishness could collapse the EUR and send Bunds right back into NIRPatory.

Which path will he take?

With that in mind, courtesy of RanSquawk, here is a full preview of what to expect (or not) from the ECB president tomorrow.

Rate Decision due at 1245BST/0645CDT and Press Conference at 1330BST/0730CDT

• All rates and the current pace of asset purchases are expected to be left unchanged


• Staff will update macroeconomic projections; impact of EUR likely to weigh on inflation outlook


• Key focus for press conference will be on recent EUR strength and possible QE exit


• Click here for a link to an overview of ECB rhetoric since the last meeting

RATE/ASSET PURCHASE EXPECTATIONS

• DEPOSIT RATE: Forecast to remain unchanged at -0.40%. The rate was last adjusted in March 2016, when it was cut by 10bps.


• REFI RATE: Forecast to remain unchanged at 0.00%. The rate was last adjusted in March 2016, when it was cut by 5bps.


• MARGINAL RATE: Forecast to remain unchanged at 0.25%. The rate was last adjusted in March 2016, when it was cut by 5bps.


• ASSET PURCHASES: Forecast to maintain the pace of asset purchases at EUR 60bln per month until December 2017. Last December, the ECB reduced the size of purchases by EUR 20bln per month, and extended the purchase horizon by nine months.

PRESS CONFERENCE

CURRENT ECB FORWARD GUIDANCE

• RATES: “The Governing Council continues to expect the key ECB interest rates to remain at present levels for an extended period of time, and well past the horizon of the net asset purchases.” (ECB statement, 20/Jul)


• ASSET PURCHASES: “Net asset purchases, at the current monthly pace of €60 billion, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.” (ECB statement, 20/Jul)


• GROWTH: “The risks to the growth outlook are broadly balanced.” (ECB statement, 20/Jul)


• INFLATION: “While the ongoing economic expansion provides confidence that inflation will gradually head to levels in line with our inflation aim, it has yet to translate into stronger inflation dynamics. Headline inflation is dampened by the weakness in energy prices. Moreover, measures of underlying inflation remain overall at subdued levels. Therefore, a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to gradually build up and support headline inflation developments in the medium term.” (ECB statement, 20/Jul)
  POTENTIAL ADJUSTMENTS TO FORWARD GUIDANCE/ROADMAP TO EXITING LOOSE POLICY


• RATES: No adjustments expected


• ASSET PURCHASES: Consensus is for no change expected to exact phrasing above. Commerzbank suggest ECB could add ‘or at a lower pace’ into the above statement.


• GROWTH: No adjustments expected (although impact of firmer EUR could be reflected in latest economic projections).


• INFLATION: No adjustments expected (although impact of firmer EUR is expected to be reflected in latest economic projections).

EUR APPRECIATION

Given the EUR’s 13% advancement against the USD this year, a key focus of the market’s view on ECB monetary policy has been on the appreciating currency. Despite this ultimately reflecting a resurgence in the Eurozone economy, the ECB will be wary of the potential impact on the Eurozone’s inflation path. As such, markets will be looking to see if Draghi talks down the currency with recent source reports (Aug 31st) highlighting EUR is worrying a growing number of ECB policymakers, adding that EUR concerns increase chance of delay in QE decision, or a more gradual exit from asset purchases. Furthermore, the minutes from the previous meeting also highlighted concerns about overshooting and as such given Draghi’s decision to not comment on the currency at Jackson Hole, markets will be highly sensitive to any potential verbal intervention by the President. **Note that existing rhetoric states ‘the ECB does not target the exchange rate’.* *

That said, ECB’s Nowotny (Sep 1st) has warned markets not to over-dramatize EUR gains vs. USD and ECB’s Hansson (Aug 23rd) also came out and downplayed the issue last month. Despite Hansson and Nowotny being two of the more hawkish policymakers at the Bank and thus in-fitting with their stances, it highlights a lack of unanimity at the ECB.

FUTURE PATH OF QE PROGRAMME

Aside from the firmer EUR, another key source of focus for the market will be on any clues as to when the ECB could begin tapering its QE programme given recent economic developments and concerns over bond scarcity. Ultimately, consensus amongst analysts suggest that this meeting will be too early for the bank to outline its plans for tapering at this stage with October seen as a more likely platform for the ECB to provide concrete policy actions; a view back by last month’s (Aug 16th) ECB source reports that suggested the council will hold off on debating the issue until Autumn. Furthermore, the minutes from the July meeting revealed the aim to ‘gain more policy space and flexibility to adjust policy and the degree of monetary policy accommodation, if and when needed, in either direction’; thus suggesting that the central bank will continue to hold off; as highlighted by Lloyds. Commerzbank also highlight the issue of bond scarcity given the current pace of monthly purchases which could cause a headache for the bank. However, Commerzbank suggest that it is unlikely the ECB would be willing to raise the limits on purchases from individual issuers and as such scarcity will have to be addressed as part of a larger policy move.

Although no explicit announcements are expected this time round, Nordea expect the ECB to comment on the preparatory work on September 7th, subsequently hinting at a decision on October 26th. However, Pictet suggest that markets may have to wait potentially longer than October with the ECB looking to avoid a disorderly exit from policy by proceeding in a cautious manner. This would be achieved by eventually scaling down purchases (avoid explicit mentioning of tapering), no mentioning of ending asset purchases initially or referring to actions as outright monetary tightening. Although it is likely that few details will be revealed during this meeting regarding how the ECB will manage their exit from current policy, the above is worth noting if Draghi et al elude to potential announcements next month.

ECB STAFF MACROECONOMIC PROJECTIONS

INFLATION: Likely to be downgraded given the appreciation of the EUR with June projections made under an assumed rate of 1.09 in 2018-2019. Nordea expect the new assumed rate to climb to 1.18 in 2018-2019 and as such, would imply lower annual inflation in 2017-19 by 0.1-0.3% points. However, Nordea also highlight that improving employment prospects in the Eurozone (which could imply higher wages) and the future oil profile could limit the extent of inflation downgrades.

REAL GDP: There is potential for 2017 growth to be upgraded given recent firm PMI data and consumer confidence, according to Nordea. However, Pictet suggest that longer-term forecasts are likely to be little changed given the possible headwinds of the firmer EUR with ING’s base case for downward revisions for 2018/19 amid FX effects.

MARKET REACTION

In terms of a potential market reaction, given the focus on EUR appreciation, FX markets will be mostly centred around any potential verbal intervention by Draghi on the currency. If Draghi is overtly cautious on recent EUR strength this will likely lead to pressure on EUR, whereas, if Draghi downplays the bank’s focus on targeting the FX rate this could provide further fuel to the EUR rally. Elsewhere, the other main source of traction will be hints on when the ECB will curtail bond purchases. It is likely that Draghi won’t offer too much on this front. However, if details are provided or Draghi is forceful about a potential unveiling of details next month, this could lead to selling pressure in fixed income markets, equities and upside in EUR. Furthermore for fixed income markets, traders will also be looking out for any potential reference to the bank’s view on bond scarcity and any possible measures which could be used to counter this issue. However, such actions are unlikely to be made this time round.

How BofA Learned To "Stop Fighting Central Banks" And Love Shorting The Euro

In a new report that may come as music to the ears of Mario Draghi, who has been valiantly hoping to show the European economy recovering while keeping the EURUSD below the "red line" of 1.20, BofA FX strategist Athanasios Vamvakidis is out with a new note today urging currency traders to "stop fighting the central banks", in other words stop selling the USD and buying the EUR, and recommends shorting the EURUSD to 1.15 with a 1.21 stop loss. 

His thesis is simple: markets have been fighting the major central banks, and BofA argues that they will be proven wrong, "leading to lower EUR/USD in the months ahead following the recent rally." Such a contrary posture by markets is unusual as markets usually follow the simple rule not to fight the G10 central banks, particularly the major ones. However, as Vamvakidis writes, "the market expects very little from the Fed in the rest of this year and next year, despite the unexpected two Fed hikes so far this year and the dot plot having four more hikes by end-2018. The market also seems to expects too much from the ECB-fast QE tapering-despite inflation being well below the target and room for slow QE tapering. The consensus is also that the two central banks will respond differently to low inflation this year, with the Fed staying on hold and the ECB giving up. We disagree and see EUR/USD weakening by the end of this year, following the strong rally so far."

He lays out the market"s explicit "expectations" as follows:

Markets expect too little from the Fed: The consensus is that the Fed will focus more on low inflation and stay on hold. "We argue that the Fed will focus more on loose financial and monetary conditions, as well as risks to financial stability from asset price bubbles, and will continue normalizing policies gradually. We also argue that US inflation could start surprising to the upside."

The current dilemma for the Fed in our view is whether to focus on inflation or financial conditions. The two have diverged this year (Chart 1). Despite Fed tightening, financial conditions have been loosening (Chart 2). However, both price inflation and labor costs have dropped (Chart 3) and credit growth has slowed (Chart 4). Overall, US data has been mixed and data surprises have been negative, although less so recently (Chart 5)

The FX strategist then contends that the market seems to be focusing on the low inflation dynamics in the US. Indeed, the market is pricing only a 30% probability for a December hike this year and less than one hike next year. If inflation is so low and has actually fallen this year, what"s the rush? As a result, risk assets have performed strongly, with equities at historic highs and volatility at historic lows.

Here BofA disagrees with this consensus for the following reasons:

• US inflation is surprisingly low given the position of the economy in the business cycle, but this may not last. The Phillips curve is not dead yet.


• The Fed is already behind the curve. Based on historical correlations, the Fed policy rate is too low to begin with compared with core inflation (Chart 11) and the output gap.


• The market is priced for perfection. Our Global Fund Manager Survey shows a record consensus for strong growth and low inflation. The risks are asymmetric if there is an inflation surprise.


• Even if inflation remains low, the Fed may focus more on financial conditions. Indeed, this is what the Fed has been doing so far this year, and for a good reason. We do not expect gradual Fed tightening to lead to even lower inflation, given that overall financial conditions are loosening and the Fed is already behind the curve. However, keeping policies too loose for too long could lead to asset price bubbles, which will eventually burst, leading to deflation risks. A forward looking Fed should take this into account, in our view. Why not take advantage of the good times to normalize policies, from a historically loose stance, to avoid risks from bubbles bursting down the road? Wasn"t one of the key lessons from the Greenspan years that monetary policies should not focus only on inflation, but also on financial stability? Don"t we know now that the Greenspan put was a policy mistake that led to moral hazard? Why repeat the same mistake twice, after having payed such a high price the first time?


• We note that the last time when inflation and financial conditions diverted was in 2013-14 (Chart 1). At that point, despite low inflation, the Fed announced and then started QE tapering, taking advantage of the market euphoria to normalize policies-and triggering the so called tapering tantrum. We expect their policy reaction function to be similar this time.

And at the same time as expecting too little from the Fed, "markets expect too much from the ECB"

ECB QE has an expiration date. For a number of reasons, the ECB does not seem willing or capable to increase the issue limit or relax the capital key in its QE purchases. QE will have to end next year. However, investors expect a relatively fast pace for QE tapering. Indeed, our Rates and FX Sentiment survey shows that most investors expect ECB QE to be over by mid-2018. Moreover, the market is pricing faster hikes by the ECB than by the Fed for the next three years (Chart 13).

Here the biggest bet by Bank of America is a simple one, and one which Yellen and most of her peers at the Fed recently warned against: the threat, and realization, that the Fed is stoking a bubble:

• We strongly disagree with the argument that central banks should ignore asset price bubbles. Eventual correction of bubbles could lead to a crisis and deflation, as we very painfully experienced in the last ten years. The Fed"s credibility will suffer if a new bubble is formed, leading to another crisis down the road. Uncertainty on what is a bubble is not an excuse to do nothing.


• Micro-prudential measures can also help to address such concerns. However, the right and the left hands of a central bank should be coordinated, to avoid offsetting each other.


• We also disagree with the argument that the policy rate is too broad a measure to target asset price bubbles. After all, the policy rate is also too broad to micromanage labor market outcomes, but major central banks have been doing it anyway, particularly after the global crisis.


• At a minimum, a central bank needs to avoid forming a bubble in the first place. Unconventional monetary policies were a way to support risk assets after the global crisis and through this channel support the economy. There was strong justification back then. However, more recently markets have been over-relying on central bank policy support, to the extent that bad news (weak data) is good news (strong equities) because they keep monetary policy loose. This is an indication of market addiction to central bank support, which the central banks have been trying to slowly address and they will continue doing so, in our view.


• Asymmetric central bank policy response to asset price bubbles-doing nothing as they are formed and easing policies aggressively when the burst-will inevitably lead to moral hazard and more bubbles.

The key conclusion for BofA is that the market may be underappreciating the concerns of major central banks, and particularly the Fed, for being responsible for the next asset price bubble and a possible crisis after it bursts. Gradual policy normalization can take place despite low inflation under the current conditions.

In FX terms, assuming BofA is right, the FX implications is simple: weaker EURUSD.

The bottom line of the above discussion is a weaker EUR/USD. We believe that given what the market is pricing today for the Fed and the ECB and by how much the Euro has appreciated this year, the risks are asymmetric for a hawkish Fed surprise and a dovish ECB surprise this fall, leading to weaker EUR/USD by the end of the year. We understand that this is a contrarian call, given the EUR/USD performance this year and particularly in recent weeks.

And the recommendation:

We introduce a new trade recommendation to short EUR/USD spot based on our above analysis. Our target for EUR/USD is 1.15, which is also our year-end projection, with stop loss at 1.21, which is above the latest peak. Spot reference is 1.1891. Risks to this trade are the Fed not hiking again this year, the ECB announcing fast QE tapering and the Eurozone economy continuing to decouple from the US.

What are the trade downsides? First, here are the good, bad and ugly scenarios:

Considering alternative scenarios and the implications for the USD:

• In a good scenario, US and global data improves and market euphoria continues. In this case, we would expect the Fed to continue normalizing policies, supporting the USD. Monetary policy divergence and risk-on should support USD/JPY in particular, but EUR/USD could also weaken. The USD could also do well against GBP if Brexit negotiations are slow-as we expect, despite a more pragmatic UK government after the elections this year.


• In a bad scenario, something triggers a sharp sell-off in risk assets. In this case, we would expect the Fed to slow policy normalization, but the ECB would still have to announce QE tapering. EUR/USD would likely appreciate, although not by much, as markets are already pricing a very slow Fed. USD/JPY would suffer the most, but we would expect the USD to still do well against high beta G10 currencies, such as AUD, CAD and NZD, and against EM.


• In an ugly scenario, the sell-off in risk assets is much stronger, risking a global recession/crisis. We would expect in this scenario JPY and CHF, followed by USD and EUR to do well, against everything else. The EUR/USD implications would depend on the specific trigger and the details, and are hard to determine in advance.

Therefore, we believe the USD would do well in most scenarios, although one would have to be selective depending on the scenario. The USD could do particularly well against high beta currencies and EM FX.

All these scenarios also point to higher FX vol. This is easy to argue for the bad and ugly scenarios, starting from a point of low volatility. In the good case scenario, our expectation for higher vol is based on our thesis for Fed monetary policy normalization.

Finally, what is BofA is wrong about central banks?

• The biggest risk we see to our view is if Yellen is replaced by the end of this year-her term as a Fed Chair ends in February-and who would replace her. It is too early to have a view on who the next Fed Chair will be and whether and how the Fed"s policy reaction function could change. We are assuming policy continuity, but we may be proven wrong.


• The second concern we have is that the Fed"s message on how its policy reaction function takes financial conditions into account, particularly when inflation is low, has been mixed. The Fed"s priorities were very clear to us under Bernanke, but Yellen has been flip-flopping, particularly this year. At times, she comes across as not having decided to respond to low inflation or to loosening financial conditions. Although we believe that the Fed will eventually do the right thing and try to prevent another bubble in assert prices, mixed messages this fall could keep markets guessing.


• We are more confident about the ECB. Their credibility is directly in question, as they are missing their inflation target and are forced to end QE next year because of technical constraints. Giving up is not an option. We expect them to use everything within their mandate to persuade markets that they will do whatever it takes to reach their inflation target. The inevitable QE tapering next year makes their work very challenging, but they could try using other tools. Otherwise, an even stronger Euro will bring them even further away from their target.


• Draghi will be faced with a very difficult communication challenge this fall. He has to announce a plan for QE tapering, despite the deteriorating inflation outlook, while persuading markets that the ECB remains committed to its inflation target. This will be tough. However, given market expectations, we see asymmetric risks from a dovish surprise.

Losing My Religion - "Central Banking Increasingly Looks Like An Act Of Faith"

Authored by Jeffrey Snider via Alhambra Investment Partners,

Well, that clears that up. In case you missed it, back on June 27 Mario Draghi triggered the latest declared BOND ROUT!!! with what was characterized as a very upbeat economic assessment for Europe. And if things are moving forward there, they just have to be everywhere else.

It came off as “hawkish” in the sense that if real acceleration is at hand, ECB normalization of first QE then interest rates can’t be that far behind. The closer we are to the first part, closer is the second. Bonds sold off, and the collective mainstream imagination ran wild.

In truth, Draghi wasn’t “hawkish” at all, nor was he all that upbeat. The media, primarily, saw what it wanted and connected dots that it had created. As for the economy, he merely stated that it was progressing. Why that was particularly important was never stated, especially since Mario Draghi always says the economy is progressing. Out of his mouth, it never is otherwise.

More important than all that, however, the ECB chief was left to try to describe the current state of our central money problem, without recognizing it yet as just that. The economy may or may not be meaningfully improved, but inflation, the economy’s chief monetary indicator along with bond rates, will not behave. For Draghi’s speech, it was characterized as a contradiction.

Following the latest policy meeting, the mainstream believes Draghi is now “dovish.” Gone is the certainty with which the world seemed to be moving toward a better place, replaced with caution and apprehension. Many ascribe this apparent 180 degree shift as a policymaker not wanting to upset markets. If bonds sold off in a rout after his last speech, he must have noticed and reacted with a more soothing posture this time.

None of that is actually going on, of course. Draghi was no more “hawkish” in late June as he isn’t now “dovish” in mid-July. At both times he was consistently confused. Today, he came as close as might be ever expected to stating that as a fact outright:

There really isn’t any convincing sign of a pickup in inflation.

As some reports noted, he stated that same thing several times with slightly different wording. The problem continues to be an absence of all the things required to make money become inflation – starting with wage growth. Without that, can the economy really be improving?

The answer is no, and even an economist like Mario Draghi knows it. In that respect, the European economy is as stuck as the US economy. When friendly outlets like the New York Times notice this lacking vital component, it cannot be as something of a trivial difference:

Central banking increasingly looks like an act of faith.

Mario Draghi, the president of the European Central Bank, and his Bank of Japan counterpart, Haruhiko Kuroda, have spent trillions of euros and yen without generating as much inflation as they want. Yet they have little choice but to insist their policies will eventually work.

The eurozone is finally experiencing a robust recovery and the only things lacking are a pickup in wages and inflation, Mr. Draghi said on Thursday.

Is it really a “robust recovery” without a pickup in wages and household income? Mr. Kuroda can answer that question best with Japan’s experience stuck for a quarter century in, of all things, Japanification. The essence of that permanent stagnation is the lack of income and wage growth, the lagging behind of households that policymakers can’t for some reason see as the most important economic element.

Work equals recovery, and with more work comes more wages. Anything else is just the shifting of numbers, the economy flying erratically like a rocket without its tail fins.

Europe’s economy is booming, except it’s not. Mario Draghi is hawkish, except he’s not. If there is one thing policymakers, media, and regular folks in all these places are starting to really understand, it’s that something important continues to be missing. They may not yet know what it is, so the focus on inflation (and the bond market) is good in that “we” are finally starting to ask the right questions.

Cranfield: "This Was A Watershed Week For The Euro: Beware Of Getting Steamrolled"

After three days of fireworks for the Euro, when it first surged on Draghi"s hawkish comments, then tumbled on the ECB"s "clarification" to Bloomberg that the market had overreacted to Draghi, then continued to surge after Draghi himself did little to dissuade the market it was wrong, the common currency is now trading at above 1.14, or 1.1425 to be precise...

... the highest level in one year, and on a relentless push higher, as the dollar tumbles, because as Sean Callow, currency strategist at Westpac says, “it will take more than anonymous ECB sources to cool the desire to bet on the euro and dump the dollar,” and adds “many investors are tantalized by the prospect of key quarterly meetings in September producing no move from the Fed but a plan to wind down quantitative easing at the ECB.”

But how did we get here so fast, just a few months after virtually every sellside desk expected parity with the USD, and what"s next? Here are some thoughts from the latest "Macro View" by Mark Cranfield, former .FX trader who currently writes for Bloomberg.

Euro Is Dancing the Macron, Draghi Two Step:

This week could be seen as a watershed for the euro, the week when all the stars align to set up a powerful run in the second half of the year. 

ECB President Mario Draghi is acknowledging reflationary forces as investors are getting comfortable with improving European economic and political fundamentals.

The tectonic plates are shifting in favor of the euro, even if some ECB members are saying that markets are jumping to the wrong conclusions.

At the beginning of 2017, research notes were being circulated with scary maps of the European electoral earthquakes ahead, starting with the Netherlands in March.

It was going to be a roller-coaster year. The rise of populism had been given a steroid boost after the U.S. presidential election and European nations were poised to follow by electing their own version of Donald Trump. The old order was going to be toppled, even Angela Merkel seemed vulnerable.

Not quite, as it’s turning out. Even the threat of a destabilizing Italian vote seems to be evaporating.

The Trump effect isn’t coming through, and the new order is being led by a staunch European supporter called Emmanuel Macron. European politics is going from zero to hero.

What a contrast with the developments across the Atlantic.

Looking at a long-term picture of euro-dollar, one can see the potential for a major breakout as bullish momentum builds up. The pair has essentially been in a range between 1.05 and 1.15 for the past two and a half years after the huge collapse in 2014-2015. If it does break the top side it probably won’t be quietly.

When the world’s number two reserve currency gets rolling, it’s probably best to get on board or run the risk of being steamrollered.

Draghi Confesses: Eurozone Needs ECB Cash

Whereas some members of the governing council of the European Central Bank were hinting the monetary policy would return back to ‘normal’ sooner rather than later, Mario Draghi, the president of the ECB, had a completely different opinion when he testified at the European Parliament.

According to Draghi, all stimulus measures need to remain in place until the Eurozone returns to a normalized inflation rate, and reducing the efforts of the ECB aren’t even being discussed.

Draghi did confirm the economy of the Eurozone is getting stronger thanks to domestic consumption and investment (rather than seeing a boost caused by external investment and export increases), but it’s still too soon to reduce the asset purchase program which will now very likely be extended.

Source: tradingeconomics.com

The ECB has also published its ‘Financial Stability Review’, which assesses the risks and vulnerabilities of the financial system as we know it. According to the ECB, the measures of the systemic stress levels in the Eurozone remained very low thanks to a slight increase of the interest rates which increased the confidence the European financial sector will be able to benefit from a larger interest rate spread to strengthen their performances and balance sheets.

This doesn’t mean the financial sector is out of the woods yet, as the ECB is explicitly warning for specific countries where the Non-Performing Loans are ‘eating away’ the profit generated by the interest spread. There’s pretty much zero doubt the ECB is referring to Italy here, and we discussed the country’s situation last week in this article. As you might remember, two Italian banks which were previously rescued by the tax-payer through a government fund once again need an urgent cash infusion to prevent a collapse.

And whilst higher interest rates on the financial markets are excellent news for the financial sector, the ECB also acknowledges these higher interest rates might actually suffocate both the private and public debt issuers. Not only will the governments have to cough up more cash to fund the interest payments on their government debt, the private sector has greatly benefited from the low interest rates. Just like in the USA, companies issued much more debt than they needed, only to spend it on non-accretive things such as share buybacks and special dividends. One good example here might for instance be Bayer’s attempt to acquire Monsanto in a $66B deal. Bayer was (and still is) planning to fund the entire acquisition with debt. A 1.5% increase in the cost of debt will result in Bayer paying $1B per year more in interest expenses. So it shouldn’t be a surprise the ECB is now also calling higher interest rates one of the main potential systemic risks.

Source: ECB

And that’s a little bit a contradictio in terminis. The ECB wants the inflation to increase which would allow it to normalize the benchmark interest levels, but if the interest rates increase without seeing a corresponding increase in the inflation rate (the natural effect of companies passing the higher price levels on to their consumers is a very unhealthy situation.

The higher interest rates for private companies are one part of the equation, perhaps an even more important part is the total debt level. And this is where the ECB is sounding the alarm bell as well. According to data provided by the OECD, the private debt in the Eurozone is higher than the historic average, ànd is higher than for instance Japan, the USA and emerging market countries.

Source: ECB

This data confirms the ECB would be nuts to stop its ZIRP and to reduce the asset purchase programme. The interest rates would increase too fast, and possibly push the Eurozone over the cliff again. We told you this before and will do so again; once you’re addicted to cheap debt, it’s really difficult to detox.

The end result? Tens of billions of freshly-printed euro’s will continue to be injected in the system. And it’s not a question of ‘if’ it will go wrong, but a question of when it will go wrong.

>>> Click here to read our Guide to Gold 

Trader: "The Plunge Protection Team Is Happening In Bonds... Right Out In The Open"

Having lambasted the market"s abhorrent response to the worst terror attack in Britain in 12 years yesterday, Bloomberg"s Richard Breslow takes aim at the flip-flopping consensus rearing its ugly head in bond land worldwide.

As he writes, it’s become very fashionable to get on the bandwagon that sovereign yields are never, or at least no time soon, going to rise.

A number of the biggest banks have joined the parade just recently. This relies largely on making the obverse of the assumptions they stated with great assurance for much of this year. It’s also borne out of impatience for this conviction view to start working already. That’s not a great investing thesis.

Contributing to this capitulation is the fact that U.S. numbers haven’t been nearly what analysts were hoping for. Even if they clearly show an economy that can’t be described as in crisis. But what isn’t accounted for in this line of reasoning is that global growth is improving further and faster than anyone factored in. It was a mistake to look at the U.S. in isolation at the beginning of the year and it’s just as questionable to do so now.

The last thing the ECB wants to do is upset the apple cart of peripheral markets, but it’s undeniable that they are beginning the process of softening up the market for an eventual change in policy.

With the numbers coming in strong and the rhetoric contemplating the when and how rather than if, every ECB event has become a major one. Whenever Mario Draghi speaks, traders will be listening on tenterhooks. After speaking in Madrid today, his next appearance will be at the post-ECB meeting briefing in two weeks. No coincidence, perhaps, that the Schatz yield is pushing year-to-date highs.

The U.S. two-year, for that matter, isn’t behaving as if last week’s Washington turmoil was a game-changer.

It’s common to point to dollar weakness and proclaim it’s a sign of a Fed that will have to climb down from its projections. Think of it instead as evidence that the rest of the world is doing relatively better. That doesn’t represent sad news and isn’t a reason to be bullish on yields.

So why haven’t yields responded? Making a flow rather than stock argument, it’s because the central banks are still buying a lot of bonds right on schedule. Are you willing to bet these amounts will hold steady or decrease over time?

People love the Plunge Protection Team conspiracy theory when looking at equities. Well that’s exactly what is happening in bonds, right out in the open.

Despite all the headlines, of late, gold is doing a whole lot of nothing. Really not suggestive of a world that expects, at least at the moment, yields to plumb April’s depths. And if they do, your stop is only a dozen or so basis points away in the tens. An interesting risk/reward.

As Breslow concludes, the best argument for buying bonds is a hedge for the long equity position you have and hate.

But while that’s legitimate portfolio theory, it may no longer fit central bank thinking. Just ask the Chinese...

Eurozone Capital Flight Intensifies: Target2 Imbalances Widen Again

"The ECB claims this action is due to its bond-buying program. I strongly disagree"

doesn"t the ECB as EuroSystem buy some 60bn of bonds per frigging month? of which some 20% of are on the ECB"s direct balance sheet?

strongly disagreeing... with the biggest movements in the eurozone, including of Target2, which some don"t even consider a balance sheet item but just a statistical device?

lol. I wonder if there is a statistic similar to T2 in any other monetary zone in the first place. perhaps there is one among the FEDs

oh, my. this kind of articles is becoming sillier and sillier. I wonder if is anybody left that actually reads them

Merkel Says There Is A "Problem" With The Euro, Blames Mario Draghi

Two weeks ago, German finance minister Wolfgang Schauble confirmed Donald Trump"s charge that the Euro is far "too low" for Germany, but said he is unable to do anything about it and instead blamed Mario Draghi. “The euro exchange rate is, strictly speaking, too low for the German economy’s competitive position,” he told Tagesspiegel on February 5. “When ECB chief Mario Draghi embarked on the expansive monetary policy, I told him he would drive up Germany’s export surplus . . . I promised then not to publicly criticise this [policy] course. But then I don’t want to be criticized for the consequences of this policy.”

Then, on Saturday, his boss German Chancellor Angela Merkel echoed her finance minister, and also admitted that the euro is indeed "too low" for Germany, but once again made clear that Berlin had no power to address this "problem" because monetary policy was set by the independent European Central Bank.

"We have at the moment in the euro zone of course a problem with the
value of the euro," Merkel said in an unusual foray into foreign
exchange rate policy.

Merkel also confirmed that Germany benefits from not having the Deutsche Mark, whose value would be far higher, and instead piggybacks on the weakness of other European nations, implicitly confirming recurring allegations that Germany benefits from the misery of Europe"s periphery.

"The ECB has a monetary policy that is not geared to Germany, rather it is tailored (to countries) from Portugal to Slovenia or Slovakia. If we still had the (German) D-Mark it would surely have a different value than the euro does at the moment. But this is an independent monetary policy over which I have no influence as German chancellor."

We showed this :fair value" divergence two weeks ago in the following chart:

Merkel"s comments addressed recent criticism by Peter Navarro, who has accused Germany of profiting from a "grossly undervalued" euro.  The chancellor made her remarks at the previously discussed Munich Security Conference, where Vice President Mike Pence was eager to reassure European allies of American "unwavering" support for NATO even as he asked the organization"s member states to pay up.

The euro has fallen nearly 25 percent against the dollar over the past three years, touching a 14-year low of $1.034 in January. But it has since risen to roughly $1.061. In late January, Peter Navarro, the head of Trump"s new National Trade Council, said the euro"s low valuation was giving Germany an edge over the United States and its European Union partners.

His comments came weeks after Trump himself said the dollar"s strength against the Chinese yuan "is killing us", deepening concerns that his administration could pursue a more confrontational, protectionist approach to trade.

Merkel and other German officials pushed back forcefully at the time, however in an odd reversal, first Germany"s finance minister, and now Merkel herself admits that Trump is right, at least when it comes to Germany, whose current account has continued to soar, and come to think of it, with Germany"s export dominance, so has the current account of Europe, which in December hit a new all time high.

A recent note by Bank of America"s Athanasios Vamvakidis confirmed how materially the EUR is undervalued relative to the USD:

Our models suggest that the Euro is undervalued, but only by about 2% in trade weighted terms. It was much more undervalued in the early days of QE, by 7%, and in the early 2000s, by 18%. However, EUR/USD is undervalued by 9.6% (Chart 4). This reflects the strength of the USD, which is overvalued by 13.4% in trade weighted terms. Compared with the rest of G10, the Euro looks cheap against NZD, CHF and JPY and expensive against NOK and SEK (Chart 5).

And so, not one but two strong hints by Germany"s most powerful politicians that Trump should take his fight against the "grossly undervalued" euro away from Berlin, and focus on Frankfurt and the ECB, and specifically Mario Draghi, will Trump"s inevitable focus on the European Central Bank - and its massive balance sheet...

... change the dynamics of European monetary policy, and prompt an even faster taper of Draghi"s asset purchases? We don"t know. We do know, however, that we will pay good money for a solid, decent twitter fight between @realDonaldTrump and the @ECB, in other USD or EUR.

Market Not Happy With Fillon Statement: Spread To Germany Spikes

Blue Horse Shoe is right. If your goal is to gamble, go puts. Risk vs Reward, you should go leveraged Treasury or Gold Miner funds. Go hard but don"t have assets expire worthless.  The short term fuckery is unmatched at this time, hell, China propped to the tune of $1tril/week these past 2 months..

"Dull Draghi" - What Wall Street Expects From The ECB Tomorrow

While ECB President Mario Draghi may sound slightly hawkish at tomorrow’s press conference after an unexpectedly strong acceleration in CPI in December and European economic growth modestly picking up, the ECB is set to argue on Thursday that its extra-easy policy stance is still needed to keep the recovery on course. As a result, it is all but certain to leave current monetary policy in place and maintain a promise for lengthy stimulus, having extended its bond-buying program just last month coupled with the tapering (just don"t call it a taper) of its bond purchases this year.

ECB President Mario Draghi can argue the bank has done its part to mend growth, but he will also note the recovery is not self-sustaining, underlying inflation is weak and political risk from key elections weighs on the outlook. So turning down the ECB taps now is inappropriate, he is expected to say.

According to Reuters, on the face of it, Draghi should be relaxed. Inflation hit a three year high of 1.1% last month (the ECB expects it to hit 1.7% in 2019), manufacturing activity is accelerating and confidence indicators are firming, all pointing to solid growth at the end of last year. Additionally, euro zone business growth was the fastest in more than five years in December, order books are surging on export demand, and consumption is holding up, despite rising energy costs, all pointing to the sort of resilience not seen since before the bloc"s debt crisis. Of course, it could all be transitory as the "Trump" effect shifts to Europe, but the answr won"t be known for a few more months.

So what does Wall Street expect? According to a Bloomberg survey, the ECB will wait until at least its meeting on Sept. 7 to announce any new policy measures As a result, Bofa strategists expect Draghi to sound “as dull as possible” to keep the message sent at the previous meeting intact. Confirming this, ECB’s Yves Mersch said on Jan. 6 that improving euro-area economic numbers and a faster-than-forecast inflation pickup aren’t enough to warrant an immediate shift in the policy.

Here is a summary breakdown of select outlooks:

BofAML (Athanasios Vamvakidis, Gilles Moec)

• Draghi will endeavor to be as dull as possible, so as not to generate too many expectations on any further change in stance any time soon


• Any deviation from the December message on the inflation outlook and/or further delay in the implementation of the new QE parameters would create scope for bonds to underperform current forwards


• Risk for euro small and balanced; any hawkish statements that strengthen the euro during the Q&A could be an opportunity to sell EUR/USD again

JPMorgan (strategists including Fabio Bassi)

• Don’t expect the ECB meeting to break much new ground; ECB will likely express satisfaction at the improvements in the growth and inflation outlook, at the same time stressing that there is no reason to think about tapering more quickly than the Dec. announcement

NatWest Markets (Anna Tokar, Giles Gale)

• Unlikely to give significant new clues to the ECB’s reaction function


• Since the Dec. meeting, data has been solid; expect the Council’s economic assessment may be slightly more optimistic, in line with the assessment of the Eurozone growth outlook


• However, policy debate should be unchanged and simply reference the decisions taken in Dec

Citi (strategists including Harvinder Sian)

• Meeting is too close to the policy moves enacted last month to warrant a material shift in ECB tone, even if data has been more buoyant than expected


• Any change to the reference of growth risks being to the downside will have to await more data and perhaps even clarity on the new U.S. administration’s policies


• Think that any further tapering risk starts from June meetings onwards, but the rise in oil prices and a drop in euro could see markets re-price from the March staff forecasts


• Expect some focus on the 33% issue limit, with Draghi likely to repeat that there are legal issues in up- sizing the issuer limit on legal grounds; many investors don’t believe the limit is a hard line in the sand –- despite the fact Portuguese and Irish bond valuations already reflect a less supportive ECB backdrop

UniCredit (economist Marco Valli)

• ECB President Draghi will sound constructive, but dovish


• He will probably acknowledge that risks in the short term are moving toward faster-than-expected headline inflation and more balanced growth assessment


• Also expects Draghi to emphasize that uncertainty remains elevated and the medium-term outlook hasn’t changed much from last month


• ECB still wants financial conditions to remain very loose

Deutsche Bank (strategists including Francis Yared)

• Next step for the ECB should be to shift to a neutral stance by removing reference that rates may go lower in the introductory statement; may be too early to do so in Jan. meeting, but the overall tone of the press conference should suggest that the policy stance is evolving in that direction

ING (Carsten Brzeski)

• The December decision has put the ECB on autopilot at least until the summer and until after the Dutch and French elections. This autopilot should also immunize the ECB against short-term volatility in macro data.

Commerzbank

• The lending channel is no longer clogged up, but it is not completely free either and progress has only been possible thanks to massive measures by the ECB. If monetary policy were to be tightened again, and the burdens from existing loans were to increase once more, the lending channel would close and the economic picture would worsen considerably again.

The 80 Billion Euros a Month Stimulus - Only Thing Holding Up Markets (Video)

By EconMatters

We discuss the final catalyst for the global asset market crash in this video, it starts and ends with Mario Draghi and the ECB, take away this 80 Billion Euros from hitting developed financial markets each month, and the entire system collapses, the quintessential Ponzi Scheme if ever there was one. The FTSE is overvalued by a substantial margin, and is a long-term short!

Central Bankers have been more irresponsible than any malfeasances that occurred in the Financial Crisis of 2007, they have set the stage with unsound, extreme monetary policies that barely helped the real economy, and succeeded in inflating the biggest bubble in Financial Markets History, that is going to cause The Biggest Global Recession in Modern History. The amount of Capital getting destroyed from such ridiculous levels is going to make the financial crisis look like a speed bump in comparison when this Ponzi Scheme Can Kicking Extreme Monetary Policy Experiment Implodes! 

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