ECB takes bold action

Rates

Yesterday, the ECB didn’t disappoint. On most points they decided what the markets like, except for the risk sharing issue. Most risk will stay on the balance sheet of the National Central Banks. (see KBC flash and our Sunset for more details). The Bund slid lower ahead of the meeting, just as it did the day before. However, following the decision, the Bund surged higher, setting a minor (but not closing) new high. Nevertheless on a daily basis the curve shifted lower especially from the 6 yr onwards. The German 10-yr fell 7.7 bps, the 30-yr yield 6.5 bps. The market had already anticipated in previous weeks on QE, pushing yields lower. Therefore, we think the reaction following the ECB decisions was positive. Equities profited too with decisive gains for the European equities (new highs) on euro weakness. Wall street and to a lesser extent Asian equities went higher as well. Peripheral spreads narrowed, suggesting that the risk sharing issue is for now of secondary importance. In the US, the longer end fell about 2 bps, while the short end increased by 2 bps.

There was some speculation that the Danish krone (peg) would become subject of speculation. The Danish central bank cut is deposit rate to -0.35% from -0.20% and intervened in the FX market, buying euros versus DKK. Markets will attentively watch how this evolves.

The eco calendar contains the preliminary estimate of the euro zone PMI’s for January, the US existing home sales and the US Markit manufacturing PMI. The focus will however turn to the Greek elections, held during the weekend. After an uptick in December, both the euro zone manufacturing and services PMI are forecast to have improved further in January. The consensus is looking for an increase in the manufacturing PMI from 50.6 to 51, while the services PMI is expected to have jumped to 52 from 51.6 in December. For both, we believe that the risks are for a stronger outcome.. In the US, existing home sales are forecast to have picked up by 3% M/M in December, following a 6% M/M decline in the month before. We see risks for a stronger outcome due to mild weather conditions and based on the development in pending home sales.

Overnight, Asian equity markets trade with >1% gains, copying bullish sentiment in Europe and the US on the back of the ECB’s QE-announcement. China underperforms. The HSBC manufacturing PMI was slightly better than expected, but remains below the 50 boom/bust mark. The US Note future trades marginally higher.

Today, the implications of the ECB’s buying programme will dominate headlines. The eco calendar contains EMU manufacturing and services PMI’s. We see risks on the upside of expectations but the PMI’s are trapped between the ECB’s QE-decision and the Greek elections (Sunday) and therefore less relevant to markets. Ahead of the Greek election and given yesterday’s post-ECB reaction on bond markets (no buy-the-rumour, sell-the-fact), we think there is little scope for profit taking today. For the Greek election, a Syriza-victory is expected but a period of uncertainty is likely with regard to coalition talks and negotiations with EU/IMF. An eventual Grexit is not our basis scenario. Greece spread narrowed in past days suggesting worries about it have eased.

The ECB delivered an open-ended commitment, including pari passu but excluding significant risk sharing. We see this as a strong statement. Once the QE programme begins, flows will play a very important role on EMU bond markets and will likely act as a key constraining influence on upward potential of most EMU bond yields. US treasuries failed to profit from the ECB’s decision. Ahead of next week’s FOMC meeting, some cautiousness is warranted. The Fed’s normalization process is still expected to start in the Summer, but so far this couldn’t weigh against the global deflation trade/hunt for yield.