How risk should be expressed heading into the ECB – Goldman Sachs

Research Team at Goldman Sachs, suggests how risk should be expressed heading into the ECB meetings.

Key Quotes

“The uncertainty over a further flattening of the German Bund n curve is too high (not to mention the valuation argument). Rather, we think that long-dated yields in France, Italy and Spain offer more value in absolute terms. If 30-year Bunds rally hard, French OATs (65bp over) Italian BTPs (175bp over) and Spanish Bonos (190bp over) would follow. If there are more purchases of Germany outside Bunds or at the front end, the ECB purchases of Italy and France would still be higher and at a longer duration, so the sell-off should be more limited. Clearly, if there is a shift away from capital key to capitalization, the periphery would gain.

We think the easing should result in a lower EUR against the Dollar. Our FX team expects a move below 1.08 and possibly as far as 1.04 in the wake of the announcement. Expectations of the ECB easing have clearly been building, but positioning is not elevated (and not as high as in December). To gain a sense of pay-outs, a ‘one-touch’ two-week FX option is indicatively priced at 8.5-to-1 for EUR/USD at 1.06 between now and close 11 March, and 18-to-1 for 1.05, and a remarkable 42-to-1 for 1.04. (EUR/USD spot was 1.1025 at the time of writing.)

Our European economics team now expects the ECB to unveil a tiered-system for the remuneration of excess reserves, along the lines of what the BoJ has introduced in January. Relative to the status quo, this should help European banks in core countries where the excess liquidity is concentrated. But, as the experience of Japan shows, concerns over the reduction of net interest margin could increase if the tiering is interpreted as paving the way for even deeper rate cuts. And, more broadly, concerns over legacy assets and the application of the Bank Recovery and Resolution Directive are still hanging over the Euro area banking sector.”