Mario Draghi explicitly referenced more stimulus during his post-meeting press conference earlier this month, but markets either didn’t get the message or else simply doubted whether there’s much more policymakers can do.
It’s not so much about the “will”. It’s about the “way”. As BofA’s Barnaby Martin put it last week, “investors don’t doubt policymakers’ desire to restore inflation, yet they question whether policy makers still have the tools to achieve it quickly”.
Well, during his speech at the ECB’s annual forum in Sintra on Tuesday, Draghi delivered the message a bit more forcefully.
“The prolongation of risks has weighed on exports and in particular on manufacturing. In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required”, he said.
If necessary, the ECB can enhance its forward guidance by “adjusting its bias and its conditionality to account for variations in the adjustment path of inflation”, he added. At the June meeting, the ECB extended its forward guidance on rates through the first half of 2020.
Draghi continued, noting that if forward guidance isn’t enough, more cuts and more QE are part of the toolkit. Here is the clip (if it doesn’t load, please refresh your page):
Suffice to say markets heard Draghi this time. The euro, for instance, dove on the comments.
The more dramatic action came in bonds. German yields, for example, plunged 6bp to -0.30%, which, for whatever it’s worth, is 5bp below BofA’s Q3 target for bund yields, delivered in the bank’s “marking to misery” note. French yields pushed 9bp lower to a record inside 2bp, while Austria’s 10-year yields fell below zero for the first time ever.
This was obviously music to the ears of BTPs. Italian yields plunged 14bps and are now 150bp below the wides hit last October during the height of the budget clash with Brussels. Amusingly, the rally in Italian bonds comes on a day when Matteo Salvini again raised the mini-Bot issue.
Obviously, this spilled over into Treasurys. US yields pushed below 2.05% as Draghi spoke and, unsurprisingly, US equity futures moved higher.
Remember, plunging DM bond yields (and especially negative yields) are a tax on safe havens. This just incentivizes risk taking, as investors are prone to forgetting that the rationale behind the dovishness is jitters about the outlook for global growth.
It is understandable that Draghi would be worried. Inflation expectations in the euroarea pushed to record lows recently and the risks to the outlook are in fact proliferating. 5y5y inflation swaps moved 6bps higher to 1.2% Tuesday – the low was 1.1% earlier this week.
Markets are now pricing 10bps of ECB cuts in September compared to 4bps yesterday.
This sets the stage for Powell on Wednesday and, potentially, Kuroda later this week, assuming he decides to make any waves. Draghi’s comments came just hours after the RBA minutes validated market expectations for more cuts down under.