Market expectations too high for Draghi to match

Length of QE program extended and a deposit rate cut. Market reaction suggests expectations were too high

At yesterday’s meeting of the European Central Bank (ECB), President Mario Draghi announced a suite of measures to further stimulate the Eurozone economy and effectively prolong the bank’s quantitative easing (QE) program. The market reaction suggests that expectations of what the ECB might have done were too high. More importantly from an asset allocation point of view, the reappearance of volatility underlines the fact that markets are moving towards an environment where central banks can no longer be as supportive as they have been in the past five years.

Mr. Draghi announced a deposit rate cut of 10 basis points, an extension of QE to March 2017 and potentially beyond that if needs be, the reinvestment of the proceeds of the ECB’s investments back into the QE program, continued refinancing programs from the ECB and an extension of QE eligible assets to encompass some regional European debt. Markets had been focused on more generous measures, notably a bigger deposit rate cut and a formal increase in the size of the monthly purchase by the ECB.

Focus now turns to the Fed meeting on 16 December
In addition, comments by Mr. Draghi as to the likelihood that inflation would rise through the next eighteen months and that the Governing Council was not unanimous on the package of additional measures contributed to a less emphatic reading of the ECB’s strategy by markets. Major government bond yields rose sharply, equities fell by approximately 2% and the euro rose by up to 2% relative to the US dollar. To some extent, the sharp market moves highlight the risks of crowded positioning and we may continue to see a balancing of long rates and short euro positions in coming days. The manner in which the Federal Reserve presents its likely rate increase on 16 December will also have a significant bearing on the EUR. In addition in forex, the strengthening of the euro may ease the pressure on the Swiss National Bank to respond to the ECB’s moves.

From an investment strategy point of view, the rise in yields plays to our underweight position in fixed income. We also highlight that in the latest Investment Committee meeting, we cut our rating on high yield to neutral from outperform. Overall in equities we are neutral, with an overweight in European equities. Though the first reaction to the ECB’s announcements is not positive, we feel that the ECB’s moves are supportive of the euro economy. Further, any more sharp moves upwards by the euro in coming weeks may provide an opportunity to add to European equities.

Credit Suisse – Investment Strategy & Research