The ECB is dealing with the same dilemma as the Fed, the RBA, the BoJ, and other developed market central banks. Namely, whether rising bond yields (a “vigilante revolt,” if you want to dramatize the situation) pose enough of a threat to the fledgling economic recovery to warrant further policy intervention.
So far, the Fed’s answer has been “no,” or, more accurately, Fed officials have generally tried to put a positive spin on higher yields, characterizing rate rise as indicative of the market’s confidence in the domestic economic recovery. Still, analysts expect Jerome Powell to announce WAM extension sooner or later. Yield-curve control, some insist, is just a matter of time in the US.
For the RBA, the situation became particularly vexing in February, as the market continually tested the central bank’s commitment to keeping the three-year anchored, and pushed longer-dated yields dramatically higher. Philip Lowe finally put his foot down on Wednesday, following Kuroda’s strategic remarks in Japan late last week.
In a good summary, Bloomberg’s Stephen Spratt reminded market participants that February 25 (which marked “peak rates tantrum”) began with Aussie and Kiwi bonds under heavy pressure, setting the stage for a day of infamy in Treasurys. That day’s “mini-flash crash started in Asia and those bearish factors, which created fertile ground for the selloff, are no longer in place,” Spratt wrote Thursday, on the way to delivering the following “lay of the land” ahead of the ECB:
- N.Z. bonds are rallying on strong demand. RBNZ upped the pace of QE buying this week and long-end QE operations have been barely covered, meaning investors aren’t willing to sell. Thursday’s bond auctions saw incredibly strong demand, with investors bidding 2bps through market levels to get their hands on the paper.
- Aussie bonds are firm after RBA turned on bulletproof mode in yield curve control. The RBA lifted repo cost for borrowing short-dated bonds, making it too expensive to short the sector and challenge the YCC. Aussie bonds now cannot lead a sell-off in long-end, they can only follow
- Japan long-end is bid since BOJ’s Kuroda pulled the rug on hopes for widening of JGB band.
The point in highlighting that brief summary is that some of the pressure is already off. Indeed, the tantrum may be over.
But Christine Lagarde was nevertheless compelled to acknowledge the realities of the recent backup in yields and confront a still tenuous outlook for the European economy in the face of a vaccine rollout that many suggest has been too slow.
ECB officials have offered varying degrees of pushback on rising yields since the global bond selloff began. The linked post (below) recounts some of that pushback.
Headed into the March meeting, the market was looking for guidance on what would prompt the ECB to deploy PEPP purchases in a targeted, aggressive fashion to tamp down yields. Of course, the ECB already targets spreads, so to the extent this conversation is new or novel, it’s about an across-the-board effort to keep yields from rising, rather than an effort to reduce fragmentation risks in the periphery.
“In highly integrated financial markets, bond market spillovers are the norm,” UBS wrote, before Thursday’s decision, adding that,
Therefore, the rise in European yields alongside US Treasurys and UK Gilts is to be expected. While the ECB’s QE purchases are unlikely to prevent an absolute increase in yields across European bond markets given the improvement in growth fundamentals, they can dampen the beta to the increase in global rates. However, at this juncture, ambiguous ECB communication and lack of aggressive action have let Bunds and EGBs trade almost in sync with global peers. Weekly PEPP purchases will remain in focus for the market in terms of understanding the ECB’s reaction function.
The ECB’s pandemic asset purchase program (PEPP) is flexible by design and it’s nowhere near being out of firepower, especially considering December’s top-up (to €1.85 trillion). No one expected that firepower to be increased on Thursday, and it wasn’t.
However, the March statement tipped a pickup in the pace. “Based on a joint assessment of financing conditions and the inflation outlook, the Governing Council expects purchases under the PEPP over the next quarter to be conducted at a significantly higher pace than during the first months of this year,” it read.
That’s notable. It suggests the GC is cognizant of the market’s concerns vis-à-vis a perceived unwillingness to step up buying. In other words, it shows the ECB wanted to address the perception of ambiguity mentioned by UBS in the excerpted passage (above).
The ECB “will purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation,” the statement went on to say. That communication is pretty unequivocal and seemed tailored to placate nervous markets.
Whether this tweak is enough to pacify traders is an open question, but at the least, it shows the ECB has its ear to the ground.
As far as the euro is concerned, some said front-loading shouldn’t have an outsized impact. “Even if the ECB were to suggest a front-loading of PEPP purchases (to contain rising bond yields), the impact on the euro should be limited, as long as the whole PEPP envelope is not extended,” ING said earlier this week.
The focus turned to Lagarde’s comments during the press conference, when new forecasts needed to reflect the changing macro backdrop without spooking markets in either direction (i.e., the projections needed to strike the “right” balance between optimism and enough pessimism to provide ample justification for ongoing monetary support).
The inflation projection for 2021 was raised to 1.5% from 1%, and 2022 to 1.2% from 1.1%. The ECB, Lagarde said, will “see through temporary inflation spikes.” She also insisted the GC “isn’t doing yield-curve control.” Rather, the bank is “preserving favorable financing conditions with a look at the inflation outlook we have.”
“Cautious optimism” is a nebulous phrase that gets bandied about in the media. But, as any central banker knows all too well, trying to define it in a way that doesn’t upset markets is often a daunting communications challenge. Lagarde seems to have done a decent job threading the needle.
Full March ECB statement
The Governing Council took the following decisions:
First, the Governing Council will continue to conduct net asset purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,850 billion until at least the end of March 2022 and, in any case, until it judges that the coronavirus crisis phase is over. Based on a joint assessment of financing conditions and the inflation outlook, the Governing Council expects purchases under the PEPP over the next quarter to be conducted at a significantly higher pace than during the first months of this year.
The Governing Council will purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation. In addition, the flexibility of purchases over time, across asset classes and among jurisdictions will continue to support the smooth transmission of monetary policy. If favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full. Equally, the envelope can be recalibrated if required to maintain favourable financing conditions to help counter the negative pandemic shock to the path of inflation.
The Governing Council will continue to reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2023. In any case, the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.
Second, net purchases under the asset purchase programme (APP) will continue at a monthly pace of €20 billion. The Governing Council continues to expect monthly net asset purchases under the APP to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.
The Governing Council also 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.
Third, 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 -0.50% respectively. The Governing Council expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.
Finally, the Governing Council will continue to provide ample liquidity through its refinancing operations. In particular, the third series of targeted longer-term refinancing operations (TLTRO III) remains an attractive source of funding for banks, supporting bank lending to firms and households.
The Governing Council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry.
Risk on, Johnny. (Sigh.) My returns may lag certain benchmarks, but I’ll never apologize for not being a buy-and-hold kind of guy.