(29 OCTOBER 2017)THE ThOUGHT OF WEEKEN: How will markets react to ECB tapering?
As expected, on 26 October the European Central Bank announced a further reduction in the pace of its monthly bond purchases to EUR 30bn from EUR 60bn and extended the program by nine months. In reaction, the Euro Stoxx 600 gained 1.1%, while the euro fell 1.4% versus the USD.
Taken at face value, a move toward monetary tightening might have been expected to support the euro and be negative for equities. But we at CIO believe the market's initial reaction – in the opposite direction – makes sense:
• The euro could continue to weaken in the near term, because while the ECB acts like a hawk, it talks like a dove. The ECB's statement offered dovish reassurance. Bond purchases will continue until September 2018 "or beyond, if necessary" and the program could be increased by size and/or direction if needed. The ECB expressed concern at the euro's rapid appreciation earlier this year; this dovish rhetoric is likely aimed at the currency. The ECB will reinvest proceeds from maturing bonds, and we believe it might target specific maturities to try curbing euro appreciation.
• The very gradual withdrawal of monetary accommodation should allow equity investors to continue focusing on upward momentum in the global economy, which particularly benefits markets such as Germany with its strong export base. We expect corporate earnings to grow by around 10% this year.
