The Return of Super Mario

As expected, last week’s ECB meeting, which ended on Thursday, resulted in an expansion of monetary stimulus and a downward revision to the central bank’s economic projections. The ECB cut its 2016 inflation forecast to 0.1% from 1.0%, and 2017 to 1.3% from 1.6%, as well as made an initial forecast for 2018 of 1.6%. Simultaneously, it cut growth expectations to 1.4% from 1.7% for 2016, to 1.7% from 1.9% for 2017 and set 1.8% as the initial 2018 estimate. The ECB cut the main deposit rate by 10 bps to -0.40%, as well as enacting a 5 bps cut to the main refinancing operation rate and the marginal lending facility rate to 0.0% and 0.25% respectively. Additionally, it expanded the value of its monthly purchases to 80 billion Euros from 60 billion, and at the same time broadened the types of securities eligible for purchase to include non-bank corporate debt. Finally, and perhaps among the bank’s most important steps, was the announcement of a new series of four targeted long-term refinancing operations that each will have a four-year maturity and rates that can be as low as the -0.40% deposit rate. This means that banks will have access to capital without having to access potentially volatile and/or expensive public markets. Shares of European bank stocks rallied on the news. Interestingly, the Euro and Euro area government bond yields fell sharply on this same news, as the announcement surpassed expectations, only to fall back later in the day to levels that were higher than where they began. German 10-year debt, for example, fell from 22 bps to just under 16 bps before ending the day at 30 bps. Ten-year Bunds have now settled around 27 bps. We have witnessed this trend before: the market prices in new information rapidly, and traders front run central bank action before unwinding those trades on the announcements and levels, ultimately settling in when the actions have taken place. We continue to believe that the Euro faces challenges and will experience low growth and inflation, limiting the level of safe haven rates like Bunds, and thereby also providing support to U.S. Treasury rates.

Sources: CNBC, CRT, FT & Bloomberg