Flash

ECB: do not miss the train

Freitag, 02/04/2022

Like the FED last week, the ECB’s official statement met market expectations but the press conference suprised.

Freitag 04/02/2022 - 12:30
Gaël Fichan Portfolio Manager & Fixed Income Lead

What we learnt?

While the official statement was in line with market expectations, the press conference was much more hawkish than expected. European Central Bank (ECB) Governor Christine Lagarde is clearly showing signs of stress (or pressure from Germany? other Central Bank peers?) regarding European inflation. She said the risks are on the upside for the next few months - a “unanimous concern” among ECB members.

European inflation, which exceeded 5% in January, is likely to continue to be above the ECB’s 2% target for some time, driven mainly by commodities (the Russia-Ukraine conflict is not helping) and supply shocks, exacerbated by Omicron’s potential impact, however small, on China’s supply chains.

Christine Lagarde has set the stage for a significant shift in March. It could be seen as a pivot in ECB monetary policy. She also indicated that:

  • PEPP (Pandemic Emerging Purchase Program) will end in March 2022;
  • APP (Asset Purchase Program) will partially offset the end of PEPP through 40 billion euros a month in 2Q22, 30 billion euros a month in 3Q22 and 20 billion euros a month thereafter;
  • It is not prudent to exclude a 2022 rate hike (10basis points?);
  • The end of APP net buying in 3Q22 is possible.
ECB quantitative tightening schedule
ECB quantitative tightening schedule
Quelle
Bank Syz, Bloomberg

What are interest rates signaling?

The front-end of the German Treasury yield curve rose sharply: the German 2-year yield saw its largest increase since December 3, 2015 (and a less dovish ECB than market expected), jumping 13 basis points in a single day.

German treasury 2-year yield net change (daily)
German treasury 2-year yield net change (daily)
Quelle
Bank Syz, Bloomberg

The Peripheral yields rose sharply during the press conference, reaching their highest levels since June 2020. The difference between Italian and German 10-year yields exceeded 150bps and the Italian curve has a positive yield from the 2-year tenor (November 2023).

Peripheral 10-year yields
Peripheral 10-year yields
Quelle
Bank Syz, Bloomberg

This morning, market participants (economists, investment bank research, brokers) adjusted their outlook based on the latest ECB meeting. They now see a high probability of a first hike in 2022.

The market also expects it, although their view is more aggressive: The EUR’s OIS Curve now calls for four hikes (of 10 basis points each) by December 2022.

ECB – Eur overnight indexed swap curve (%)
ECB – Eur overnight indexed swap curve (%)
Quelle
Bank Syz, Bloomberg

But this optimism that the European economy is so strong also raises the question of whether the resilience of European economy could offset this potential tightening of monetary policy. And for now, the market’s answer is clearly negative with the acceleration of the flattening of the German yield curve: the German Government curve is now the flattest it has been since 2008 (!)

Yield differential between 5-year and 30-year German government bonds
Yield differential between 5-year and 30-year German government bonds
Quelle
Bank Syz, Bloomberg

What credit market is telling us?

In sympathy with European equities (-2%), the credit market took the news badly with Investment Grade (above BBB-) credit spreads rising the most since the mid of 2020.

The European High Yield market also performed poorly on the news. The average credit spread of the US High Yield market reached a new 1-year high, putting further pressure on the 2022 performance which have already lost more than 1.5% in January).

European high yield - average credit spread (in bps)
European high yield - average credit spread (in bps)
Quelle
Bank Syz, Bloomberg