Draghi in no hurry to spook the market, just the Euro
Draghi in no hurry to spook the market, just the Euro. European Central Bank (ECB) President Draghi wants to engineer a smooth transition away from ultra stimulative monetary policy…but not too soon, because inflationary forces remain depressed. The problem is the strength of the Euro, which further depresses inflation. The ECB wants a weaker Euro…
At the last ECB press conference, Draghi commented that there were ‘two…observations of this nature ([on] the link between the asset purchase programme and the inflation convergence), but there wasn’t any discussion…on normalisation’. This very measured language highlights the mindset of policymakers: cautious to ensure that inflation and wage gains are gaining a solid foothold. Inflation across the Eurozone was flat in June, contributing to a 1.3% annual growth over the past year. We must remember the mistake that the ECB made in raising rates in 2011, only to have to cut rates before year-end 2011.
In this way, the ECB remains conservative with their communication on the need for tapering, with President Draghi noting that ‘discussions should happen in the fall’ because ‘we are not there yet’ regarding inflation and price stability. President Draghi does not want a taper tantrum to push borrowing costs sharply higher. But a weaker Euro would be of assistance, both for lifting inflationary forces and for boosting economic demand.
The market has misjudged the reticence of the ECB
We feel that the market has misjudged the reticence of the ECB and that confidence in aggressive tapering in coming months misguided. In turn we feel the Euro bounce during the press conference will be transitory. Indeed, the long Euro trade is overcrowded, with futures market positioning at the highest level in over six years. In the face of weak inflation pressure, there are downside risks for the Euro. Meanwhile, option pricing shows that optimism, albeit trending higher, is much more subdued than within the futures market.
As a result, we continue to expect the near-term Euro strength to falter and to move lower until a more urgent need for tighter monetary policy for the Eurozone becomes a more strongly voiced position.
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnold joined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
European domestic and infrastructure-related sectors likely to outperform
ETF Securities Fixed Income Research: European domestic and infrastructure-related sectors likely to outperform
European domestic and infrastructure-related sectors likely to outperform
Summary
Infrastructure-related corporate bond sectors likely to benefit the most from the ECB’s Corporate Sector Purchase Programme (CSPP).
The CSPP will also be particularly supportive for corporate bonds issues from the euro area core.
The ECB’s support for larger firms will likely have a positive impact on growth and employment figures.
ECB’s programme and EU challenges
As widely expected, the ECB left policy rates and the amount of monthly purchases (EUR80bn) unchanged at its June meeting. The Corporate Sector Purchase Programme (CSPP), which started on June 8, is part of the broader EUR80bn monthly purchase. It will include corporate bonds with a maturity from 6 months to 30 years and with a minimum rating of BBB- (i.e. Investment Grade). The national central banks will buy on behalf of the ECB, with the ability to purchase up to 70% of any individual bond.
ECB president, Mr Draghi, has also stressed the need for countries to focus on rising productivity and improving business environment, by enhancing public infrastructure and reducing differences in financing conditions between member states as per Juncker’s “Investment Plan for Europe” announced in November 2014. We believe the CSPP is genuine way to deepen and integrate capital markets in the euro area. Moreover, by including Investment Grade (IG) euro-denominated bonds issued by non-financial corporates (NFCs) to its programme, the ECB is now enlarging its support to larger firms with potential larger impact on growth and employment figures. In this regard, the CSPP is likely to remain in place at least until 2018 or beyond but we don’t expect the ECB to disclose the time frame.
Fundamentals
The economic recovery in the euro area is continuing, albeit with signs of a moderation in growth due to a weaker external environment. In June, the ECB staff revised upward real GDP growth forecast for the euro area to 1.6% in 2016 (up from 1.4% forecast in March), and the annual inflation to 0.2% from 0.1% in March, reflecting the recent oil price rebound.
The fundamentals of European non-financial IG corporates have improved significantly since the beginning of the year, showing a rebound in profitability as well as a downward trend in leverage ratio (from 3x in 2015 to 2.5x in average). The continuing improvement of the economy in the Eurozone should stimulate risk appetite and thus drive European spreads tighter.
Market performance
Our estimate of the amount of eligible CSPP Eurozone corporate bonds outstanding is approximately EUR757.5bn, of which 13% are yielding below zero. In our opinion, the ECB could buy between EUR5bn to EUR10bn monthly, leading the ECB to own between 4.5 – 9% of the current supply by the end of the year.
Euro denominated corporate bonds have outperformed dollar and sterling denominated counterparts so far this year. We expect bonds issued from the core – namely Germany, France and Netherlands – to outperform bonds issued from peripheral countries in the near term since the core countries represent about 70% of the bonds eligible for the CSPP. Since the start of the CSPP, OAS credit spreads on Peripherals IG have widened 4.3bps, while the spread on European HY widened 10.3bps. But as the programme intensifies, investors will rotate more aggressively from Core European IG to Peripherals IG and HY in search for yield. Accordingly, it could be a good entry point into peripheral and HY European corporates.
Sector performance
Since the announcement of the CSPP on March 10, European non-financial corporate bonds (within the BBB rating bracket) tightened by 48bps on average. We believe the CSPP will likely be most beneficial for European Utilities and infrastructure-related sectors. These sectors represent the largest proportion of the bonds eligible for the CSPP (32%), according to our estimates.
The aforementioned sectors have seen a significant improvement of their profitability since the beginning of the year. The profitability of European Utilities and Consumer non-cyclicals sectors has rebounded significantly year-to-date.
In contrast, Energy and Financial corporates experienced declining profitability. Energy sector still remains under pressure due to volatile oil prices. Insurance companies – which are eligible to the CSPP – face asset/liability mismatches as European populations are rapidly aging while the prolonged low yield environment significantly reduced investment income and squeeze margins. Additionally, banks’ net interest income and loan margins are declining as a result of the ECB’s negative deposit facility, and they are excluded from the CSPP. Accordingly, we believe Financial corporates will underperform in the medium term.
Despite improving fundamentals, spreads widened in May and subsequently tightened following the ECB meeting on June 3. The recent tightening more than offset the widening in May for most sectors, with the exception of Utilities, Consumer Staples and Consumer Discretionary where we believe opportunities still remain. Since the Eurozone recovery is mainly domestically driven, we believe domestically focussed sectors such as Consumer Staples, Consumer Discretionary and infrastructure-related will outperform the globally exposed sectors (Energy and Industrials). Furthermore, infrastructure-related sectors appear to be the sectors targeted to increase the growth potential in the euro area.
Moreover, we believe the bulk of opportunities remains in long dated IG European corporate bonds, which have outperformed the short dated bonds so far in 2016. The potential market knock on effect should be a gradual shift in market issuance to longer dated bonds since the programme will likely reduce the cost of funding, together with higher duration risk. However, the ongoing deleveraging of the European corporates’ balance sheet should prevent an unexpected spike in primary market activity.
Conclusion
We believe the CSPP is likely to remain in place until 2018 and the monthly purchases could be increased later this year or early 2017. Thus, we believe opportunities remain in core European BBB credit market, especially in domestic and infrastructure-related sectors as well as in long dated bonds.
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This communication has been provided by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).
This communication is only targeted at qualified or professional investors.
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.
This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.
Infrastructure and utility sectors likely to benefit the most from the ECB’s programme
Infrastructure and utility sectors corporate bonds likely to benefit the most from the ECB’s Corporate Sector Purchase Programme (CSPP). The programme will also be particularly supportive for corporate bonds issues from the euro area core. The ECB’s support to larger firms will likely have a positive impact on growth and employment figures.
As widely expected, the ECB left policy rates and the amount of the monthly purchases (EUR80bn) unchanged at its June meeting. But, Mr Draghi announced that the Corporate Sector Purchase Programme (CSPP) will start on June 8 and that the first operation of TLTRO2 will be conducted on June 22. So far, we know that the CSPP – part of the broad EUR80bn monthly purchase – will include corporate bonds with a maturity from 6 months to 30 years and with a minimum rating of BBB-. Also, national central banks will buy on behalf of the ECB up to 70% of any individual bond.
More importantly, Mr Draghi stressed the need for countries to focus on rising productivity and improving business environment, by enhancing public infrastructure and as per Juncker’s “Investment Plan for Europe” announced in November 2014. We believe the CSPP is a genuine way to deepen and integrate capital markets in the euro area, which was one of the main challenges addressed by the Juncker’s plan for a Capital Market Union (CMU). Overall, small and medium-sized enterprises (SMEs), which rely on banks for 80% of their financing, have benefited most from the ECB’s programmes so far. By including Investment Grade euro-denominated bonds issued by non-financial corporates (NFCs) established in the euro area in the list of assets that are eligible for regular purchases, the ECB is now enlarging its programme to also support larger firms with potential larger impact on growth and employment figures. We believe the start of the CSPP next Wednesday will likely be most beneficial to European infrastructure and utilities corporate bonds. The Infrastructure and Utility sectors together represent the largest proportion of the bonds eligible for the CSPP, according to our estimates (up to 55%). Furthermore they appear to be the sectors targeted to increase the growth potential in the euro area.
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
Valutamarknaden mäter risken på den globala finansmarknaden
Valutamarknaden mäter risken på den globala finansmarknaden Finansmarknaderna togs nyligen på sängen när Mario Draghi, ordförande i Europeiska centralbanken (ECB) meddelade en sänkning av alla ECBs styrräntor tidigare under mars. Mest notabelt var sänkningen med 10 punkter, från minus 0,3 procent till minus 0,4 procent, på inlåningräntan. Utöver detta adderade ECB ytterligare 20 miljarder euro kvantitativa lättnader vilket innebär totalt 80 miljarder på månadsbasis. ECB har också expanderat till inköp av tillgångar som företagsobligationer av hög kvalitet, vilket är en markant förändring från tidigare verksamhet. Valutamarknaden mäter risken på den globala finansmarknaden.
Nytt låneprogram som kommer att pågå i fyra år
Dessutom meddelade Draghi ett nytt låneprogram som kommer att pågå i fyra år för att göra det möjligt för bankerna att kompenseras för att ta in ECB pengar om de expanderar sin utlåning till företag i euroområdet.
De flesta av dessa åtgärder var oväntade, och allt återspeglades så klart på valutamarknaderna. Den 10 mars, den dag som Draghi tillkännagav detta, omsattes det fler valutakontrakt på den amerikanska derivatbörsen CME än vad som tidigare omsatts på börsens 44-åriga historia. Totalt sett omsattes 2 517 334 terminer och optionskontrakt, och därmed slogs rekordet från den 6 maj 2010 med 146 000 kontrakt.
Av förklarliga skäl var en hög andel av de avslut som gjordes i Euro, både terminer och optioner. Den dagen omsattes det kontrakt till ett underliggande värde på 113 500 miljarder euro. Hela volymen kan emellertid inte tillskrivas ECBs agerande. Samtidigt som ECB kommunicerade sina nyheter pågick också den så kallade terminsrullningen, något som normalt ökar på handelsvolymen.
Ett starkt år för valutahandel
Så här långt har 2016 visat sig vara ett starkt år för valutahandeln, den dagliga volymen för handeln i japanska yen mot den amerikanska dollarn hat till exempel ökat med 38 procent jämfört med året innan. Handel i den valutan kommer till stor del från marknadsaktörer som söker en fristad på valutamarknaden under tider av volatilitet.
I takt med att volatiliteten på energiråvaroroch metaller har ökat har vi också sett en ökad handel mot valutor hos emerging markets, och så kallade ”råvaruvalutor”, det vill säga valutor i länder där råvaruexporten har en viktig ekonomisk betydelse. Dessa valutor inkluderar till exempel:
Australiensiska dollar 21 procent
Kanadensiska dollar 32 procent
Brasilianska real 23 procent Mexikanska peso 35 procent
Indiska rupier 11 procent
Valutamarknaden fungerar som ett riskreducerande verktyg
Allt detta visar hur valutamarknaden speglar andra delar av finansmarknaden och fungerar som ett riskreducerande verktyg när vissa andra tillgångar visar sig vara mindre förutsägbara.
När centralbanker fortsätter att använda nya politiska verktyg och råvaror fortsätter att söka prisstabilitet, kommer handelsaktiviteten på valutamarknaderna fortsätta kräva ett vakande öga. Valutamarknaden mäter risken på den globala finansmarknaden.
ETF Securities FX Research: A global recession is just hype
Summary
Market dynamics in 2016 indicate that investors fret over the possibility of a global recession. There is little evidence or likelihood of this happening.
Central bank policy is bowing to market pressure to raise stimulus. The same stimulus measures that once had an impact are failing and new ideas are needed.
The Euro appears headed higher as the ECB again disappoints the market.
During 2016, share markets have mostly been in freefall, (in line with bond yields), and global asset volatility has surged. Investors appear concerned that the global economy is about to experience a recession. In turn, markets are expecting and most central banks seem willing to provide fresh stimulus to support economic activity. While such actions can produce a short-term impetus for risk appetite, it is unlikely to provide a sustained improvement in the underlying economy. New thinking is needed.
While investors are concerned about another global slowdown, and that market weakness could provide a negative feedback loop to the real economy, there appears little evidence of this occurring. The value of more and more of the same QE and lower and lower rates appears dubious, as does the reality surrounding recession fears. Economic data shows that activity isn’t stellar but it not in recession territory as investors fear.
(Click to enlarge) Source: Bloomberg, ETF Securities
The US and the UK economies remain robust, with good growth rates around 2%, and unemployment back near pre-crisis levels. Swedish Q4 2015 growth rose to the highest level in four years.
Eurozone unemployment remains elevated but has reached the lowest level in four years. Services sector buoyancy is offsetting weakness in manufacturing and overall growth is hovering at 1.5%. Even concern over the European banking sector seems misplaced. Although loan growth is stagnant, margins appear stable and non-performing loans have been falling for around 12 months, down 30% since the March 2014 peak.
Clearly oil exporters like Canada and Norway are struggling and require stimulus. However, other commodity currency countries (Australia and New Zealand) and faring well, with growth rates in the 2-3% range. Japanese growth has been stagnant for many years, despite some evidence of gaining traction. Nonetheless, negative rate environment has not assisted the real economy or kick-started inflationary forces. And the strong currency is hurting the Swiss economy, which is weakening sharply.
Who’s been doing what?
The main policy that G10 central banks have been implementing have been similar: a combination of asset purchases, so called quantitative easing (QE) and lowering interest rates (some into negative territory). While the impact of such policies appear to be losing their potency, policymakers appear to be pandering to market whims and simply responding to rising asset volatility.
Over the past year, six of the G10 central banks have cut rates and three are below zero, and appear ready to do more. At some point, moving rates further negative will either force banks to lend to increasing risky borrowers or enforce negative rates on its customers (potentially causing depositor flight). In an uncertain economic environment, neither choice is very palatable for banks. This leaves the option of central banks pushing rates further into negative territory as one that has limited gains and could keep FX volatility elevated. Inflation expectations are significantly correlated to oil prices, a weight on inflation that is generally accepted by central bankers to be a temporary influence. Accordingly, central banks shouldn’t be reacting to the volatility that the oil price movements are having on overall market sentiment. We feel that volatility is moderating and knee jerk policy reactions are likely to be a mistake and generate unintended consequences.
(Click to enlarge) Source: Bloomberg, ETF Securities
The impact on currency?
The beggar thy neighbour nature of central bank stimulus on currencies appears to be very myopic, short-lived and unlikely to have a sustained (if any) impact on trade. The idea that efficiency gains can drive rising export volumes seems flawed. The ‘J-curve effect’ is likely to take several months before improvement is seen in trade volumes. The UK and the US are the top two trading partners for the Eurozone countries, accounting for around 25% of total exports outside the Euro Area. In order for a meaningful improvement in trade, a sustainable depreciation in the Euro is required. This will not happen if the ECB continues its recent method of promising more than it delivers.
Additionally, rising FX market volatility has certainly been a factor in curbing the ambition of policymakers seeking competitive depreciations of local currencies, by limiting the timeframe of the currency response to policy changes.
(Click to enlarge) Source: Bloomberg, ETF Securities
Draghi to the rescue?
The next policy signpost is this week’s ECB meeting. Expectations remain high that the central bank will cut interest rates further and add to its QE program. Although most G10 central banks do not have a specific currency mandate (objective), it comes as no surprise that central bank policy indirectly impacts currencies. ECB President Draghi noted at its January meeting that, ‘ it’s pretty clear that our actions have an effect on the exchange rate’.
Interest rate differentials matter for currencies in any environment, but particularly when yield is such a scarce commodity as it is currently. In order to have a sustained impact on the local currency (the so-called easy win for efficiency gains), the central bank has to do more than its competitors, something that isn’t happening. Central banks need to send positive signals to market participants if they believe (as we do ) that the global recovery remains on a recovery path. Buying riskier debt instruments within the QE program can help restore some normalcy to government bond markets by switching more QE demand to private sector debt markets.
Composition of ECB balance sheet remains firmly skewed to government debt purchases. The ECB’s Public Sector Purchase program, of which the vast majority is sovereign bonds, accounts for over 75% of its QE asset purchases. The main difference between the Asset Backed Security Purchase Program (ABSPP) and the Covered Bond Purchase Program (CBPP3) schemes is that covered bond purchases remain on the balance sheet of the banks and purchases under ABSPP program can help relieve balance sheet stress of the banking sector because the debt pool is taken off balance sheet – something that investors have been acutely worried by in recent months. Nonetheless, both programs can help lift demand for the underlying bonds and motivate lending to (riskier sectors of) the real economy, as rates remain historically low, thereby repairing the credit transmission mechanism and supporting growth. The ECB could also loosen the criteria for eligibility for the ABSPP and CBPP3 programs.
(Click to enlarge) Source: European Central Bank, ETF Securities
Without further risk taking from the ECB and its ability to differentiate itself from other central banks in terms of generic QE and declining rates, the Euro is likely to reverse course and become a burden for the economic union’s trade volumes. The ECB has consistently over promised and under delivered and we expect next week’s meeting to again disappoint.
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This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.
This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data.
Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.
ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.
