ECB meeting to have broad implications - BBH

The ECB meeting this week is going to have broad implications as many observers cited the ECB's tapering as evidence that the forces of divergence were exhausted.  

Key Quotes

“A new convergence was declared, but it has not materialized.  The US two-year premium over Germany is at its widest since 1999.”  

“The consensus call until a few weeks ago had been for the ECB to bring down its monthly asset purchases to 40 bln euros a month from 60 bln and extend the purchases for six months.  We had thought a large reduction would maximize the flexibility to end the program.”  

“Based it seems on mostly unsourced reports, the market now expects a larger reduction of the purchases, but for the duration to be extended for nine months.  There is a debate over what is more important, the monthly purchases or the duration of the program.  We are inclined toward the latter because in the current context, the signaling effect (forward guidance) is particularly important.”  

“Due to the sequencing that the ECB has outlined, favoring no rate hikes until after the purchases are complete, the longer the purchases, the more distant is the first rate increase.  The market appears to have given up on ideas of an ECB hike next year.  The euro may be sensitive to signals that the ECB wants to push expectations out further into 2019.”  

“Perhaps the different markets may respond differently to the trade-offs.  The coupon curves may be more sensitive to quantities rather than the duration of the program.  In the first instance, if the purchases are scaled back to 20 bln euros, it might be a bit disappointing.  In the second instance, with coming maturities can average 10-15 bln euros a month, whose proceeds will be recycled, we suspect that some emphasis on gross purchases could be part of the signaling effect.”  

“Some look for the ECB to try to secure greater flexibility its purchases, and abandon monthly targets and instead focus on the overall size.  The Financial Times recently reported:  "Officials think there are about 300 bln euros worth of eurozone bonds left they could buy.  They would prefer to commit to purchases of slightly less than 300 bln euro to have some room to speed up should conditions deteriorate."  

“We are not completely persuaded.  After all, the ECB has changed the modalities several times, to include corporate bonds, for example, and it has increased the universe of other non-sovereign issuers.  There is some thought that the ECB could tweak the other assets that it is buying, including asset-backed securities and corporate bonds.  Nevertheless, if the total net amount of bonds the ECB commits to buy is more than 300 bln euros, the market's response may be more dramatic.”  

“While providing an end date of its purchases is possible, the ECB likely will try to maximize its flexibility.  When it reduced its purchases from 80 bln euros a month to 60 bln euros starting this past March, it argued it was not tapering because there was no termination date.  By the same logic, don't be surprised if the ECB refrains from discussing its re-scaling as tapering.”  

“The ECB may also choose not to show its entire hand at this meeting.  It may hold back details of either its purchases, new initiatives, reinvestment of maturing proceeds, or modify the terms of the existing targeted long-term repo operations (TLTRO) for the next meeting.  While these may be important for individual participants and in some market segments, investors are unlikely to wait for such details before judging the ECB's stance.”