The ECB attempted to exceed market expectations

Comments on ECB meeting and global fixed income themes from the BlackRock’s Global Unconstrained Bond Team

The ECB attempted to exceed market expectations with a strong set of non-conventional monetary policy measures but then disappointed the market on forward guidance around further interest rate reductions – effectively suggesting that interest rates had reached their nadir.

While they delivered pretty much bang on consensus expectations with the deposit rate cut, taking it from -0.3% to -0.4%, they also reduced the main refinancing and the marginal lending facility rates by 5bps each, taking them down to zero and 0.25% respectively. Interestingly, however, during the press conference President Draghi stated that a tiering system was not introduced for the deposit rate because the Governing Council did not want to signal that rates would keep on being reduced.

We believe it is highly significant that he emphasised that future policy easing is likely to shift from rates to other non-conventional measures.

Critical changes to the asset purchase programme were also unveiled. Most significantly, the ECB will add non-bank investment grade corporate debt to the asset class composition of QE, while monthly QE purchases will also increase by €20bn to €80bn.

Finally, a new series of targeted longer-term refinancing operations (TLTRO II) will be launched from June 2016. This step is also very important because it will enable banks to borrow at rates as low as the deposit facility rate, i.e. negative, compared to the previous TLTROs which were at the refi rate.

The market reacted swiftly to the change in policy stance, with peripheral sovereigns rallying. The euro, however, sold off versus the US dollar on the news before rebounding strongly during the press conference.

The ECB’s outlooks for real GDP growth and inflation have both been revised down. GDP growth and HICP inflation are forecast to be 1.4% and 0.1% in 2016 respectively, rising to 1.8% and 1.6% in 2018. Some of the headwinds to growth cited included sluggish growth in emerging markets, slower global growth and the need for structural reforms in many European economies, while the lower price of oil was noted as a contributor to low inflation.

It was notable that the Governing Council went into their discussions with 10 year German and Italian government bond yields, as well as inflation expectations, at very similar levels to those of one year ago when ECB commenced its QE programme.

§ In terms of our positioning in Europe, we continue to like peripheral European sovereign bonds and the above mentioned shift to non-conventional measures further supports that investment view.

In addition, we have a favourable view of certain longer-dated inflation-linked bonds both in Europe and the US. We believe that the meagre break-evens that have been priced in are very low, particularly in light of central bank inflation targets.

While much recent market attention has been on the Bank of Japan and ECB’s easing measures, we continue to believe in the diverging monetary policy theme. Market views about the interest rate path of the US Federal Reserve repriced at the start of this year, down to just two hikes priced in through to the end of 2017. Given the ongoing strength of the labour market and core inflation appearing to firm, to us this looks quite conservative.

Finally, while this is proving to be a tough environment for emerging markets, we continue to see idiosyncratic opportunities in both rates and FX. A relatively long-standing view, India still remains one of our favourite positions, where we are long local currency Indian government bonds and Indian banks and are also long the Indian rupee.

Marilyn Watson – Head of unconstrained fixed income product strategy – BlackRock