Harkster Previews: ECB Decision Tree - Oct 25
Today’s focus… Will Lagarde reduce PEPP or raise the minimum reserve requirement?
Consensus:
The market is fully priced for the (data-dependent) pause... A severe contraction in Manufacturing PMI is spreading to services weakness as the composite index has now dropped to a 3yr low and raises the risks of a technical recession in Europe, employment is stalling especially in Germany, the ECB lending survey showed credit standards tightening and demand for loans decreasing (Christophe Barraud - September Eurozone Monetary Developments Reinforce Recession ), Chinese/Global growth data weakening, geopolitical concerns in the middle east, no new staff forecasts until Dec and recent FCI tightness / term premium is doing their job for them. If anything, the ECB's job has become easier/clearer since their last meeting, with the majority of data confirming their pause and it's now up to the hawks to argue the case for more hikes, rather than the doves having to convince them not to hike.
Lagarde is most likely to repeat her September message = data dependent plus higher for longer.
Will Lagarde stick to a hawkish tone to temper labour wage demands despite clear weakness in sentiment data?
The renewed risks of an energy shock and subsequent upside risks to inflation is the key hawkish trigger if the ECB feel they will miss their 2025 inflation target of 2%.
However, doves will indicate that the energy supply linkages from the middle east are barely comparable to the impact the gas shortage had during the onset of the Ukraine/Russia war.
Given her limited rate guidance, the focus will be on other tools...
Will they accelerate the reduction of their bond holdings?
Will they raise the minimum reserve requirement?
These discussion points are still at an early stage, given the September minutes had mentioned they had barely started.
Furthermore, PEPP reinvestment slowdown will most likely occur in Q1 2024, at this stage it is unlikely the ECB would want to trigger a further widening of the Italian-Germany spread (Chart 1 below). Pressure on the periphery is always bad news for EUR.
However, it is also difficult to understand how the ECB can continue to make purchases in the name of "pandemic" relief...
Chart 1: Italy vs Germany 10yr yield spread ...
Source Bloomberg
What’s in the price?
Rates are firmly unchanged for tomorrow's meeting
There is a small nod to the probability of another hike by year end given oil price risks, sticky inflation, gas price rise since Sept and new forecasts due in Dec. ECB Lane has also said "the ECB needs to be open to doing more if new inflation shocks emerge"
... but really the focus is on 2 cuts next year, as the market can see the recession coming in Europe well before the US. The first full cut priced by June!
There are in total 4.5 cuts priced out to 2y = 110bps...
Chart 2: WIRP Eurozone
Source Bloomberg
Limited action in the vol market...
EURUSD O/N vol is a spread below 11 and at the top end of its 6-month range. This implies an atm straddle breakeven of 46bps / 50pips. From a 1.0590 close.. that's 1.0540-1.0640 expected range, which won't even test the Oct extremes (Chart 3 below)
9.8 vol for 1-week EURJPY looks a lot more interesting, discounting any move from BoJ relative to its July meeting (Chart 4 below)... 110bps (170pips )breakeven for the 1week atm straddle that contains two CB meetings, one of which may intervene and/or tweak its YCC if the board see inflation reaching 2% in its forecast horizon.
Chart 3: EURUSD .... overnight implied vol for ECB expects us to remain within the Oct range
Source Bloomberg
Chart 4: EURJPY 1 week vol..
Source Bloomberg
If you found this preview useful, please give it a ‘Like’ at the bottom of the page. It only takes a few seconds and helps our free commentary reach a wider audience. 🙏
HarksterHQ Decision Tree:
If you found this preview useful, please give it a ‘Like’ at the bottom of the page. It only takes a few seconds and helps our free commentary reach a wider audience. 🙏
Top Sources
Discovered on Harkster.com
Nordea - EUR rates: ECB trades
Livesquawk - ECB Policymakers Head For Athens And A Likely Rate Hold
Notayesmanseconomics - The ECB can expect to hear more calls for interest-rate cuts in the Euro area
ZeroHedge - The Bigger Risk To Bunds Comes From The BOJ, Not So Much The ECB
Steno Research - ECB & Fed Watch: Closing in on ECB rate cuts, while the Fed is not done hiking
Econostream - ECB Insight: On Hold, Not on Pause, but Still With a Hawkish Bias
Saxo Markets - ECB preview: it can only be a pause
Stay informed throughout the day with our new commentary feed (‘Intraday Market Colour’) highlighting key notes, topics du jour, and HarksterHQ’s market updates around key data points and headlines.
Available on the Harkster Research Platform.
ㅤㅤㅤ
The information provided in this post is for general information purposes only. No information, materials, services, and other content provided in this post constitute solicitation, recommendation, endorsement or any financial, investment, or other advice. Seek independent professional consultation in the form of legal, financial, and fiscal advice before making any investment decision.