The ECB is on deck and given recent rhetoric from policymakers, some market participants are getting a bit nervous about the prospect of a disappointment.
At the July meeting, the statement clearly paved the way for a rate cut, the possible introduction of tiering and a restart to net asset purchases. “The Governing Council has tasked the relevant Eurosystem Committees with examining options, including ways to reinforce its forward guidance on policy rates, mitigating measures, such as the design of a tiered system for reserve remuneration, and options for the size and composition of potential new net asset purchases”, the statement read.
Since then, the data has been weak, especially in Germany, where the manufacturing downturn shows no signs of abating. Nascent signs of stabilization in PMIs notwithstanding, the growth outlook is poor and euro-area inflation remains parked at 1%, half of where it was a year ago.
And yet, policymakers in Europe have been keen to downplay market expectations for a restart of ECB QE.
To be sure, much of the pushback has come from arch hawks. Klaas Knot weighed in on August 29, for instance, days after Jens Weidmann chided that the ECB shouldn’t “act for action’s sake”. But then Sabine Lautenschlaeger got in on the act, as did Madis Muller. Even the outgoing Ewald Nowotny said central banks should be prepared to disappoint markets when expectations run too far out ahead of policy.
Now, one has to wonder if the bar for a dovish surprise has been set impossibly high, even for Mario Draghi.
“The single currency’s downtrend took a breather last week as numerous ECB members downplayed the elevated market expectations for policy easing at this week’s meeting”, Barclays writes on Sunday, highlighting that “the main pushback centered on the prospects of fresh QE, resulting in a sell-off in European duration”.
The bank still harbors relatively lofty expectations for the ECB to deliver. Here’s a handy table which captures both Barclays’ forecast and the market’s collective base case:
(Barclays)
Again, expectations are high. And yet, given the pushback on QE, it’s possible that the realization of expectations for a restart to net asset purchases could still be seen as a dovish “surprise”. Barclays touches on that.
“We think last week’s headlines have led a non-negligible segment of the market to think that the bar for additional asset purchases is rather high [so] we see scope for modest rates positive/EUR negative market moves should QE be announced”, the bank says, before cautioning that while even a “slightly smaller depo rate cut versus market pricing should still validate cumulative expectations of rate cuts over the coming year if coupled with the introduction of mitigating measures, no announcement of mitigating measures would significantly disappoint markets, in our view, even if the ECB delivers a larger-than-expected cut this week, resulting in a steeper EUR money-markets curve and a stronger currency”.
This is quite a challenging setup, and one that could turn out to present a pretty vexing quandary for anyone trying to parse the statement in real-time when it’s released, 45 minutes prior to the press conference.
In his latest, BofA’s Barnaby Martin says the bank expects Draghi to “again embolden markets with rate cuts and QE”, but acknowledges that “the ECB ‘hawks’ are making this decision a lot trickier”. Martin expects a return to corporate bond buying to be part of any new QE, but notes that “contrary to March 2016, today’s credit market is already flush with marginal buyers [and] adding another will simply make excess demand conditions in Euro credit even more favourable”.
And yet, has demand run out ahead of reality, where “reality” means the amount of delivered easing? Maybe. Have a look at the following chart:
(BofA)
“What’s clear is that markets are priced for a good outcome”, Martin remarks, pointing out that “inflows into fixed income are running way ahead of the amount of central bank easing to date”.
And so, there is indeed a very real risk of a let down. “If next week proves to be underwhelming, then markets are vulnerable to correction”, Martin goes on to say. “As always, the onus will be on Draghi to convince the disbelievers”.
Let’s see if he has one more rabbit in the hat before handing the reins to Christine Lagarde.
Who actually thinks this still works in the real economy?