June 05

Draghi Declares Lower Bound on Rates

Out of all the confusing headlines and policy changes from the ECB today, the most noteworthy quote was Mario Draghi stating that his central bank is now at the lower bound on policy rates. This means that rates will not be cut any further. Additionally, another quote saw the ECB chief say that “the OMT has nothing to do with this” when speaking on the OMT program’s relationship to the SMP or ABS asset purchases. This statement made it seem as if large unsterilized purchases of sovereign debt (QE) are still an unlikely option. Draghi made it clear that any asset purchase program will be targeted at the asset backed security market, for reasons we have covered in a previous post.

In all, the ECB delivered what was expected. A 10bps cut in the refinancing and deposit rates. A targeted 4 year LTRO, extension of fixed rate full allotment and suspension of SMP sterilization. We’ve discussed in recent days that the focus would be on future easing, namely the prospects for QE. On this front Mario Draghi failed to convince markets in what at best was a mediocre performance by the usually confident ECB president. Draghi’s normal swagger was not there today, he didn’t seem to talk about these new policies with any real conviction. He also lacked a decisively dovish tone. Draghi could have really talked up the ABS asset purchases but didnt give any specifics, only reciting a new line in the statement which says “Preparatory work related to outright purchases of asset-backed securities intensified”.

A point I have been hammering on twitter is that the ECB missing expectations for it’s much awaited easing represents a shift in sentiment towards tighter global monetary policy. Emerging market currencies, specifically the South African Rand and Turkish Lira are vulnerable to the ECB and FED moving towards tighter monetary policy relative to expectations. These two currencies fluctuated today during the ECB press conference, but there was a notable turn higher in the EUR and lower in ZAR and TRY in the moments after Draghi stated that the ECB is now at the lower bound on policy rates. In the 5 minute charts below the EURUSD appears on the upper left, the yellow lines represent the common moves seen in the wake of Draghi’s statement that the lower bound was reached. US Stocks fell along with emerging markets currencies while the EUR rallied. Subsequent moves in these charts after the ECB press conference seem to have been unrelated, the Dollar has sold off somewhat and stocks remain higher.



We have to ask why the Governing Council would include this language on the lower bound? Last month they pre committed to ease this time, but this month they have essentially pre committed to not cutting rates further. One would have to expect that including this language must have been a trade off to get the unanimous agreement of the Governing Council. This could imply that some corners of the council (Weidmann) wanted today’s actions to basically be seen as ‘this is as far as we will go’.

In other markets gold rallied almost 1% initially,the US 10 year yield is down 2bps to 2.59% but the 2 year US yield saw a bigger relative move with it falling 1.5bps to 0.385%. German 2 years are steady at 0.5%. The SPX is rising, up 0.40% at the moment. European stocks closed off their highest levels of the day which were seen before Draghis declaration that the lower bound had been reached. The German DAX closed up 0.20%, the French CAC higher by 1.1%. The Euro seems to tell a story of disappointment, the currency is far off it’s lows of the day. Most other assets have moved in a fashion that would tell us that the ECB succeeded in convincing markets of its easing bias, for now.