ECB Ends QE And, Critically, Enhances Forward Guidance Around Reinvestments

Ok, so Draghi is up to bat on Thursday and the word is, the ECB will trim their inflation and growth forecasts today.

Specifically, the inflation outlook is expected to be revised “slightly weaker” than the 1.7% seen previously. Here, for reference, is where things stood as of September:

(Bloomberg, ECB)

Obviously, the headlines today will revolve around confirmation that the ECB is ending QE, and that confirmation comes at a precarious time. Risks to the outlook are multiplying, both within the bloc and externally. Italy is clearly a problem (Rome’s recently conciliatory stance on the budget notwithstanding), Brexit is a risk, European equities are in a tailspin and € credit is suffering from ongoing outflows as the allure of USD “cash” saps demand.

(BofAML)

“Our concern for 2019 is that the hubris from the QE era will come back to bite”, BofAML’s Barnaby Martin recently wrote about the prospects for € credit in the new year. “Debt maturities rise substantially over the next few years because companies took the easy route and issued short, not long, yet, the two big marginal buyers of credit — the ECB and retail investors — are now absent”, he continued, in same December 7 note, before warning that on BofAML’s calculations, “there will be a demand deficit in high-grade to the tune of €125bn next year.”

The truly ironic thing here for € credit is that last week (i.e., in the week ahead of the meeting during which the ECB will confirm the end of QE), additional outflows took us right back to pre-QE levels.

(BofAML)

Additionally, economic momentum is clearly waning. Here’s GDP and the Citi Eco Surprise index:

(Bloomberg)

And core inflation is hardly what one might call “gangbusters”:

(Bloomberg)

In addition to the new forecasts, market participants will be watching closely for any evolution in the forward guidance. Remember, Draghi put a dovish spin on things when he first tipped the end of APP back in June. His adoption of state-and-date dependent forward guidance was key, and was widely applauded for the extent to which it mitigated the hawkishness inherent in QE wind down. Now, market participants will be keen on parsing the statement and presser for any clarity on the infamous “at least through the summer” language. Here’s Barclays:

We think the current forward guidance on short rates “…key ECB interest rates to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary…” is already dovish in its current form and does not require a change. The current Eonia pricing over the next few years is already notably more dovish than after June 18 ECB meeting (ie, when new dovish short rate guidance was announced), as well as versus what the surveys suggest (Figure 3). In any case, we think the current guidance is flexible enough to make the first depo tweak later, if needed (ie, December 2019), and, at the same time, still keeps the door open for a September 2019 move if macro backdrop allows. Given that this decision is still too far out, we do not think there is much upside for the ECB to lose this optionality.

Note that in the right pane there’s a survey about the reinvestment schedule. Markets will be intently focused on this now that the monthly flow of new asset purchases is flatlining. Notably, if Draghi tips any kind of “Operation Twist” (or any other nuance that suggests the GC might try to use the reinvestments as dovish cover for a rate hike before 2020), it could play euro positive.

Also in focus will be any hint at new TLTROs, especially at a time when there are questions about the European banking system in light of Deutsche Bank’s ongoing trials and tribulations and, especially, considering how fragile Italy is.

The perceptible lean towards fiscal largesse both in Italy and now in France (following the “Yellow Vest” protests) is another concern.

So that’s the backdrop. We’ll have more later, but for now, you can find the new statement below and the immediate takeaway is that the ECB has enhanced its forward guidance on reinvestments. This is big news. They have now committed to reinvestments beyond the first hike. 

December 13, 2018

At today’s meeting the Governing Council of the European Central Bank (ECB) decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively. The Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

Regarding non-standard monetary policy measures, the net purchases under the asset purchase programme (APP) will end in December 2018. At the same time, the Governing Council is enhancing its forward guidance on reinvestment. Accordingly, the Governing Council intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.