He will also pave the way for Christine Lagarde toward a potential sovereign quantitative program, if it becomes necessary. Lagarde will,
in all likelihood, be appointed ECB president by October and hold her first ECB press conference on 12 December. On the same day, the ECB
will present its biannual macro projections, which are usually the basis for major policy decisions.
We continue to believe that sovereign QE would require more economic pressure, so it is not part of our base case. However, we will carefully
monitor macroeconomic data, the Federal Reserve, and geopolitical risks (including trade wars and Brexit) to validate our call.
We still expect two rate cuts of 10 basis points each, the first one in September and the second in October (previously forecast for
December). The decision whether to conduct sovereign QE would likely be announced at the December press conference held by Lagarde.
We think a sovereign QE program faces significantly higher hurdles than lower interest rates. When it announced its last sovereign QE
program in January 2015, the ECB committed to spend over EUR 1 trn until September 2016—effectively a 20-month time horizon. Given the
uncertain global trade environment today, the risk is
that such a program might be too large or too long.
After the recent sell-off in Bunds, yields have again been pulled down across the curve close to all-time lows. This is mainly due to continued
global trade tensions, associated recession fears, as well as anticipation of ECB easing, with over 25bps of rate cuts priced in over
the next 12 months. Renewed tensions over Italy’s fiscal policy and a no-deal Brexit would intensify flight-to-quality into Bunds.
With Bund yields negative up to 15 years, the euro investment-grade market remains one of the few positive-yielding alternatives to
government bonds, and this segment should continue to see inflows from investors reallocating funds from the high-grade space, in our
view.
The strong market technical backdrop should remain a key support for the EUR IG segment, and spreads might continue to grind tighter as a
result. However, even though we see spreads being comparatively well supported at current levels, we note that fundamental pressures
are building over the longer run.
While the gradually weakening economic outlook and trade risks should generally weigh on risk premiums for lower-rated government bonds,
additional QE purchases would provide support to risk premiums of bonds eligible for purchase.
As we expected, the ECB did not yet announce a tiered system for bank deposits. While the Governing Council is examining tiered deposit
rates, we believe they would likely be announced along with a rate cut, which we expect in September. The signal sent to bank
shareholders and creditors, and the potential favorable shift in sentiment toward the sector should the ECB become more supportive of
European economy banks, should not be underestimated, in our view.
In recent days, the euro fell hard due to surprising relapses in Eurozone flash PMIs, raising expectations for a strong ECB easing. The ECB
decision, however, supported the euro as it delivered less-concrete action than expected. EURUSD rose back toward 1.12 after briefly
touching 1.11.
Since the ECB decision in September remains uncertain, we expect the euro to be driven by several factors. The two main drivers are economic data surprises and the Fed’s monetary policy. The probability of ECB easing rises with soft European data and a dovish Fed decision. Surprises that could potentially lift the euro are hawkish statements by Governing Council members who today blocked more forceful easing measures.
By UBS
