Italian supply: Unattractive pricing?

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Markets doubt effectiveness of ECB’s measures

The ECB clearly delivered more than the market expected (see below), but market enthusiasm dissipated faster than it arrived as Draghi strongly suggested that the deposit rate won’t be cut again. That’s also why the ECB didn’t introduce a tiered deposit rate system. If more easing needs to be done, it will have to be done via other non-conventional measures. We suspect that G-20 participants agreed not to start a currency war via ever lower negative rates.

The ECB eventually ended up with stronger euro, weaker equities and higher yields. That’s not exactly the financial easing where they aimed at. If it isn’t rapidly reversed, the ECB will be the big loser of its own actions and risks to stay side-lined for a long time, unable to reach its objectives. Will fiscal policymakers, entangled themselves in an existential refugee crisis and the Brexit referendum, come to the rescue anytime soon? We can only doubt. In a daily perspective, German yields rose up to 10 bps with the 2-to-5-yr underperforming. The 10 and 30 yr yields rose by 6.5 and 5.8 bps respectively. The market almost completely priced out further deposit rate cuts.

More specifically the ECB cut its refi rate and marginal lending rate by 5 bps to 0% and 0.25% respectively. They lowered the deposit rate by 10 bps to -0.40%. The pace of monthly QE-purchases increased from €60B/month to €80B/month and investment-grade, non-bank, corporate bonds became eligible. Buying corporate bonds could unlikely be done in size though. It might turn out to be a side-show like the ABSPP this year. Additionally, the ECB raised the issuer and issue share limit from 33% to 50% for securities eligible for international organisations and multilateral development banks. A new series of four targeted longer-term refinancing operations, each with a maturity of four years, will start in June 2016 on a quarterly basis. Borrowing conditions in these operations happen at the repo-rate (0%), but can be as low as the deposit rate if banks lend out more than the lending benchmark the ECB defines! Counterparties will be able to borrow a total of up to 30% of a specific part of their loans (corporate and household non-mortgage lending), less any amount outstanding under the (by 2.5% at as 31 January 2018) will be charged at a lower rate, but minimal the deposit rate (now -0.40%). These new TLTRO’s look advantageous for banks given the long tenors and the zero or lower financing cost, but given the amount of excess liquidity and the slow increase of demand for loans, it remains to be seen whether there is a sizeable net take-up (old TLTROs may be rolled into the new ones). Aside from the first TLTRO1, the uptake in subsequent TLTROs1 was disappointing. We also question the effectiveness of this measure.

Italian supply: unattractive pricing?

The Italian debt agency taps the on the run 3-yr BTP (€1.5-2B 0.3% Oct2018) and 15-yr BTP (€1-1.5B 1.65% Mar2032) while also creating a new 7-yr BTP (€3.5-4B 0.95% Mar2023). The bonds on offer didn’t cheapen in the run-up to the auction and especially the Mar2032 is expensive on the Italian curve. Grey market trading suggests that the new 7-yr BTP will be priced with a 0.3 bps pick-up in ASW spread terms compared to the previous 7-yr benchmark (1.45% Sep2022). That’s a 8 bps pick-up in yield terms. We believe that the pricing of the three BTP’s isn’t really attractive, which could hamper demand. The US Treasury concluded its mid-month refinancing operation with a solid $12B 30-yr Bond auction. The auction stopped well through the 1:00 PM bid side and the bid cover was in line with the prior year’s average (2.33).

More downside ahead

Overnight, most Asian equity markets trade positive with China underperforming. The oil price is marginally higher and the US Note future has a downward bias, suggesting some weakness in the Bund opening.

Today’s eco calendar is empty so markets can further digest the ECB meeting (see KBC FLASH). Draghi delivered on additional easing, but warned that rates won’t be cut again. The market reaction (bear flattening yield curve) suggests that investors no longer believe in the effectiveness of the experimental monetary policy. The ECB’s armoury is also running low on ammunition and several of yesterday’s non-conventional measures are nothing mere but eyewash. Extreme positioning was evidently another reason for the huge move. We believe that yesterday’s move could go further, but of course not at a similar pace.

Going forward, we think that there is a firm bottom below rate markets in yield terms. The ECB doesn’t intend to lower rates further and also gives the Fed more leeway to become more hawkish. The German 10-yr yield tested 0.3% resistance (neckline double bottom). A break higher becomes very likely and would be a signal to sell the Bund. Last week, three other important markets already broke more or less similar key technical levels. The Brent oil price ($37.55/barrel), S&P 500 (1950) and US 10-yr yield (1.85%) all moved above resistance levels, painting double bottoms on the charts. This suggests that risk sentiment changed compared to the beginning of the year (more positive) and gives more downside for core bonds).

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