ECB PREVIEW: Draghi Seen Hurting Bunds by Echoing Sintra Script

  • Citigroup, Barclays see meeting as bearish for German bonds
  • Upside risks for euro currency as JPMorgan raises forecast

European Central Banks Watch ECB for Policy Clues

Barclays Plc and Citigroup Inc. suggest this week’s European Central Bank meeting may be bearish for bonds in the short term, with the institution expected to gently prepare the ground for an announcement on tapering of asset purchases.

Analysts also see positive risks for the shared currency heading into Thursday’s decision, with President Mario Draghi likely to repeat the tone of his Sintra speech. JPMorgan Chase & Co. strategists have revised their forecast for the third quarter higher by 6 percent to $1.15 and those at Morgan Stanley recommending to buy any dip toward $1.12. Euro overnight money market rates are currently pricing in the first full 10 basis points of rate increase for September 2018, with an additional eight basis points priced by year-end.

Here is a selection of views from notes sent to clients:

JPMorgan Chase & Co. 

  • The bank has revised its short-term euro forecasts against the U.S. dollar with ECB seen as taking a more active role in preparing markets for a tapering of QE, strategists including Meera Chandan said in a note to clients last week
  • The forecast for the third quarter is revised to 1.15 vs previous 1.08 while the target for the 4th quarter is at 1.16 vs previous 1.15 since the Fed will be in motion as well
    • Base case is for the ECB to announce taper in the September meeting
  • Any explicit reference to September would also likely be accompanied by an emphasis that the inflation outlook still warrants an accommodative monetary policy to avoid an overly hawkish interpretation by markets

Bank of America Merrill Lynch

  • The ECB is likely to toughen its language marginally, by removing the easing bias on the QE, while insisting on the need for prudence and a “persistent” monetary stimulus, strategists including Gilles Moec, Athanasios Vamvakidis, Ruairi Hourihane said in a client note dated July 14
  • Expects the meeting this week to be slightly positive for the euro
  • The bank’s central scenario for next ECB moves is the following:
    • September pre-announcement of a decision on the future of quantitative easing in October, with QE to be scaled back from EU60b to EU40b for six months starting in January 2018 and regular tapering in the second half of 2018, ending in December 2018 and accompanied by a technical deposit rate hike

Goldman Sachs Group Inc.

  • Analysts including Lasse Holboell Nielsen don’t expect Draghi to try to unwind the market re-pricing since the Sintra speech on June 27, when he said “the threat of deflation is gone and reflationary forces are at play”
  • The bank expects a further signal in the autumn, probably in September, of the ECB’s intention to taper during 2018, with details on the path of the purchases over the course of the year to be announced in December, strategists said in a July 11 note

Morgan Stanley

  • Many central banks have turned tighter, either by action or by rhetoric; still, all actions were carefully communicated as being gradual, strategists including Hans Redeker, Anton Heese said in client notes
  • ECB’s communication should underline gradualism too and this is why “we see the euro trading within a corrective pattern that is time consuming,” they added
  • Strategists remove the bearish bias on European rates by closing short 10y Bund vs UST and turn neutral, given the risk Draghi backtracks and says the ECB sees no signs yet of underlying inflation rising

Barclays Plc

  • Draghi may want to reinforce the Sintra speech not though any policy/text changes but via the question and answer section, strategist Cadgas Aksu writes in a client note dated July 13
  • ECB may reinforce view that September meeting could be seen as an opportunity for policy reassessment, which would be perceived as a bearish signal
  • In terms of positioning, recently closed outright short 10y Bund trade on July 7, however continue to hold bearish expressions such as reds/greens EONIA steepener and short May 18 EONIA trades

Citigroup Inc

  • Look for Draghi to reinforce the hawkish signal sent by the speech at Sintra, as it makes little sense for a dovish turn at the July meeting before a taper announcement in September or October, strategists including Andrea Appeddu write in a client note
  • Root cause of the ECB shift is the technical need to terminate ECB QE buying in 2018 given the 33% legal limit, not the inflation outlook
  • Given this, the net takeaway from the July ECB meeting is likely to be bearish for European rates
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