With ECB gone, focus turns to Fed

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Dovish ECB: slower, but longer

Yesterday's ECB decisions contained a number of surprises. Some additional (dovish) Draghi comments pushed markets in the ECB's desired direction. Core bonds eventually found their composure after an initial hawkish reaction in a volatile environment. When dust settled, the curve had steepened sharply via substantial lower ST yields and considerably higher very long term yields. Together with the drop of the euro and the rise of equities, it suggests that markets interpreted the ECB's decision as dovish.

For an in-depth analysis, see our flash report.

The ECB will extend its APP beyond March 2017, but at a lower amount of €60B/month (from €80B/month) till at least December 2017, or beyond if necessary. The maturing bond proceeds will be reinvested. The monthly amount of purchases may be raised again or the duration of APP increased if the outlook becomes less favourable or if financial conditions are inconsistent with further progress towards the inflation objective. Draghi not once mentioned the possibility of a tapering in case of the inverse situation, namely stronger growth and faster rising inflation. He shunned the word tapering, fearing it could cause a tantrum. The change in some technical parameters of the programme affected markets too, as they weren't neutral for all EMU countries. Bonds with a maturity of 1-to-2-yr become eligible and if needed bonds yielding less than the depo-rate (-0.4%) may be bought too. This means that more short-term bonds will be bought than before. These changes helped steepen the curve, in line with the Japanese curve after the recent BOJ decisions. A helping hand for the banking sector? The measure will support especially Germany, Netherlands and Finland to fulfil their part of the bond buying (scarcity problem). The decisions surely better anchor short term rates and generate a steeper curve.
A weaker euro is an additional gain. So, Draghi certainly succeeded for now in his mission to dissociate the EMU situation from the US one and the ECB's policy from the Fed's one. They can now let the current programme run till the end of 2017, before eventually changing track and start tapering, even if one can never exclude an improving situation which warrants earlier tapering (low risk). While their actions cement the front end of the European yield curves for longer, we're not sure whether they cap the upward potential for long term yields. The jury is still out.

In a daily perspective, the German yield curve steepened sharply with 2-yr yields down 6.5 bps, while 10 and 30-yr yields ended 3.7 to 10.4 bps higher. The US yield curve bear steepened with yields 1 bp (2-yr) to 7.2 bps (30-yr) higher.
On intra-EMU bond markets, 10-yr yield spread changes versus Germany ended close to unchanged with the periphery underperforming. The Spanish spread added 5 bps, the Italian one 8 bps and the Portuguese one 21 bps. Portugal and Ireland (+2 bps) suffer as the ECB didn't raise the issuer limit, which is the biggest constraint for both countries in the APP and might result in reduced buying and likely ultimately in a premature end of APP for these countries' bonds. For other peripherals, the reduced amount of buying may have a negative effect too and especially Italy and its banking problems need to be watched closely.

With ECB gone, focus turns to Fed

Overnight, Asian stock markets trade mixed. The US Note future is slightly lower while Brent crude gains limited ground. If any, it suggests a slightly weaker opening for the Bund.

Today's eco calendar is thin with only US Michigan consumer confidence. We don't expect that figure to impact trading as markets will further digest yesterday's ECB policy decisions. They cement the front end of the European yield curves for longer, we're not sure whether they cap the upward potential for long term yields. From a technical point of view, the German 30-yr yield tested key resistance yesterday. Overall, global markets will also start counting down to next week's FOMC meeting. A rate hike is discounted, but will the Fed governors already changes their dots for next years in a hawkish way? This factor of uncertainty might keep some investors side-lined, suggesting some sideways trading.

Technically (US), the US 2-yr yield broke above 1.1% resistance. The test of the US 5-yr yield to break above the 1.85% area and the test of 2.5% resistance in the US 10-yr yield currently didn't succeed. The US 30-yr yield remains below a similar 3.25% mark. We wait for specific news (e.g. a hawkish Fed next week) before anticipating a break higher (5yr & 10 yr). We hold our sell-on-upticks approach in US Treasuries.

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