ECB Meeting Today: a difficult communication exercise

Rates

Yesterday, global core bonds eked out good gains. Like Wednesday, there was no catalyst for the price action (empty calendar), which happened despite positive European equity sentiment. European investors are clearly nervous going into the ECB meeting. In a daily perspective, the German yield curve bull flattened with yields 1.3 bps (2-yr) to 6.6 bps (30-yr) lower. The US yield curve shifted in a similar way as the German curve with yields up to 7.3 bps lower at the very long end of the curve. On intra-EMU bond markets, 10-yr yield spreads versus Germany ended close to unchanged with Portugal underperforming (+9 bps). Portuguese bonds are under pressure as Socialist Leader Costa said that he can form a leftist government with the support of Left Bloc and the Communists.

Eco calendar better filled, but ECB meeting key

After last week’s strong US jobless claims numbers, initial claims are expected to have increased to 265k this week from 255k last week. We see no specific risks to the expectations. The September existing home sales are expected to have increased to 5.39m in September, coming from 5.31m in August, up 1.5% M/M. We see some downside risks to this number, based on the pending home sales (two month moving average declined 0.6% in August), which generally lead the existing sales. The October Eurozone consumer confidence indicator is expected to worsen from -7.1 to -7.4 according to the consensus.

ECB and Draghi in difficult communication exercise

The ECB and its president Mario Draghi face a difficult communication task this afternoon (for a full preview, see FLASH). Signals from ECB members suggest that the ECB won’t take new measures today. However, Mario Draghi (and the ECB) adopted a quite aggressive easing bias, which raised hopes in the market for more easing, albeit not particular for this meeting. However, Mario Draghi needs to keep the easing hopes alive. Certain elements might have made the ECB slightly less eager to ease short term. The lending survey was positive and the eco data remained encouraging with also upward revisions to the GDP of previous quarters.

There was no improvement on the inflation side tough, the main preoccupation of the ECB. Finally, the euro strengthened against the dollar and on a trade weighted basis. Not enormously, but enough to be very cautious. The ECB should also take into account the risk that the Fed won’t hike rates this year, which would put extra pressure on the euro. A strengthening of the euro would be very unwelcome. For these reasons, we still think that Draghi won’t take the risk of disappointing markets and keep its aggressive easing bias in place.
December might be a better timing for a move as the ECB will have new Staff forecasts and a better grip on the global growth outlook and its impact on EMU growth and inflation.

Today: Dovish ECB meeting

Overnight, most Asian stock markets trade in negative territory in line with yesterday’s WS weakness. The S&P 500 failed to break back north of the 2040 mark and fell prey to profit taking. The US Note future is marginally lower. We expect a neutral opening for the Bund.

Today’s main trading theme is the ECB meeting. We expect the central bank to keep policy unchanged. Following Draghi’s aggressively dovish tone at the September meeting, he’ll have a hard time proving that he is readier than ever to step up stimulus. We expect that he’ll be capable of doing so, which is a positive for the Bund. However, such scenario is to a huge extent discounted in rate markets. Therefore, the negative reaction in the Bund will be proportionally larger in case Draghi doesn’t live up to dovish expectations. Apart from the ECB meeting, we keep a close eye on main European and US stock indices. Especially in the US, they show signs of topping after failing to take out key resistance. More profit taking is possible which could eventually take us back to the recent lows. That could underpin demand for bonds via safe haven flows.

Technically, a combination of dovish central banks (ECB eyes more easing; Fed delays lift-off) and a potential new correction on equity markets underpins the core bond market. We believe that a new test of the contract highs is likely, but these resistance levels recently proved to be tough. On intra-EMU bond markets, the prospect of a left government is a short term negative for Portuguese OT’s.

ECB Meeting Today: a difficult communication exercise