It was supposed to come with a “bang.” Instead, the double trial balloon launched by the ECB on Thursday night, delivered at the same time by both Reuters and Bloomberg to make sure that everyone got it and according to which the ECB was considering slashing its QE in half from €60 billion to €30 billion and keeping the program active for at least 9 months, revealed one of the biggest market reaction “whimpers” to an ECB leak in years.
For those launched by the ECB on Thursday night, here again are the bullets:
Perhaps the market reaction was unexpectedly muted because the announcement was i) largely in line with expectations and ii) still to be finalized. Naturally, the lack of an acute selloff in Bunds (and rates globally) was welcome news to the European central bank, for which another major bond tantrum would be the worst case scenario, one which could promptly unravel the entire carefully planned pre-tapering edifice.
The problem, however, is that the complete lack of a reaction failed to give Mario Draghi a sense of whether the €30 billion bogey was too high, too low or, maybe, just right.
Still, as Citi’s Harvinder Sian writes in a Friday note, the market impact from the ECB meeting is likely to be determined by the signaling channel for policy rates which is imbedded in the QE extension. In other words, the final framework of the ECB’s QE will certainly move markets, “although the purchase horizon is not the only variable that matters: the size of purchases will signal whether QE is most likely to come to a hard-stop or be open to continuation.”
So what are the possible scenarios for the ECB to achieve it aim of tapering without tantrum, and via signaling. That will require a judgement on how the rates market will react to the new calibration of size and horizon, of which there are many options.
To answer that question, Citi take a look at the market impact from the various ECB policy permutations.
The starting point is that rates do not rise until ‘well past’ the net asset purchase period. The purchase horizon, however, is not the only variable to assess because a hard-stop at €20bn is easier to envisage than a hard-stop on a €40bn announcement. We look through these size/horizon combinations and model the EONIA curve for timing of the first rate hike, time to zero rates and the average hike per meeting thereafter. That is the framework for assessing euro swaps and Bund impacts. The bullish to bearish scenarios for 10yr Bunds range from -25bp to +24bp (one-week impacts) from current levels. The market neutral level of APP extension appears to be around +€250bn.
