Comments on the 22 October European Central Bank (ECB) monetary policy meeting and global fixed income themes from the Global Unconstrained Bond Team.

  • With only two months left, all of the action spurring the major central bank monetary policy divergence that so many people expected in 2015, ourselves included, has been firmly on the easing side.

Decidedly dovish Draghi

  • The ECB certainly remains in the easing camp. Today it maintained its refinancing rate at 0.05% and the deposit rate at -0.2% but, significantly, President Draghi noted that the Governing Council discussed a cut in the deposit rate. Overall, he struck a decidedly dovish tone and opened up a very real possibility of further QE or a cut in the deposit rate in December.
  • Draghi noted several downside risks to the eurozone’s growth and inflation outlook in the press conference and stated that the ECB will act to support inflation if necessary. Commenting that they will reassess their monetary policy stance in December and that this week all instruments were discussed, with no clear preference, he even noted that a few members of the Council had hinted at using additional tools today.
  • Within the eurozone we retain our preference for Portuguese and Slovenian government debt. We believe that the healing process remains underway in these economies and that there is further room for this to be reflected in bond spreads. In addition, we are positioned with a long Spain versus short Italy relative value trade and short the euro versus sterling.

What will the Bank of Japan do?

The Bank of Japan (BoJ) is also firmly on the loosening side, with their inflation target of 2% by mid-2016 looking increasingly unrealistic. The burning question now is how will they address this problem? Possible options include lowering the inflation target, extending the time horizon, increasing QE or a combination of these. All eyes will certainly be on the BoJ’s monetary policy announcement next week.

When will the Fed lift-off?

  • In the US, the Fed funds rate has been at a record low of 0.125% since December 2008. There is now a lot of uncertainty around the exact timing of lift-off. Chair Yellen has made it clear that the Fed remains data dependent and, while recent statements suggest December may be a possibility and there are a lot of important data releases between now and then, the extra dimension of concern about Chinese growth was also introduced in September.
  • US inflation expectations as expressed via breakevens remain very low and the market is fully pricing the first hike closer to summer 2016 than December 2015. In our view the balance of probability is tilting towards the Fed waiting for a few more data points. Either way, December is shaping up to be an important month for central bank watchers.

What does this mean for the Bank of England?

  • In the UK we remain positioned on the gilt curve with short or negative duration. The first move above the current 0.5% base rate, which has prevailed since March 2009, is not fully priced by the market until 2017. While we do not believe that the Bank of England (BoE) will raise rates before the Fed and despite low core inflation and a negative reading for September’s headline CPI release, we view the lag priced in by the market as excessive.
  • As such, our long sterling versus short euro currency position is predicated on our view of increasing dispersion between the policy stances of the two central banks. The BoE’s November Inflation Report should provide further clues about the expected timing of rate normalisation.

Are there opportunities in EM?

  • Finally, India remains one of our favourite positions in the EM space, where we are predominantly long local currency Indian government bonds and Indian banks. We are also long the Indian rupee, along with a basket of EM currencies that includes the Mexican peso, South African rand and Indonesian rupiah based on valuations and their sharp depreciation against the US dollar. We are just starting to see signs that these FX adjustments are helping to boost exports and, in isolated countries such as South Africa, we are even witnessing an increase in capital inflows.

 

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 22 October 2015 and may change as subsequent conditions vary.
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