1、1 31/05/19 ECB:Is tiering the trick up Draghis sleeve?KEY MESSAGES Our base case is that next Thursday Mario Draghi will announce(relatively generous)details of TLTRO III,combined with dovish language.Against a backdrop of falling inflation expectations,the ECB president might want to add more meat
2、to the bone,however.If thats the case,we think the choice might fall on rate-tiering.We have long argued that tiering is an effective instrument in the ECBs toolbox and would eventually be implemented.The ECB could move in that direction as early as the June meeting in an attempt to restate its comm
3、itment to price stability.A pre-announcement(with scant details,TLTRO-style)could be accompanied by a further extension of and/or a change in the forward guidance to allow for the possibility or rate cuts.Any sustained decline in EUR 5y5y inflation of 25bp or more over six months has generally been
4、accompanied by ECB action(Fig.1).This was the case on 27 March when ECB headlines suggested that tiering was under consideration(see:ECB-Increasing risk of verbal intervention).Since then EUR 5y5y inflation has fallen further to 1.29%,and is within sight of its all-time low of 1.25%.Given our view t
5、hat there is an increasing risk of a more decisively dovish ECB,we recommend a bullish stance in rates.Any pre-announcement of tiering is likely to have a positive impact on bank stocks and bank credit.We retain our short recommendation on EURJPY.The spread in Eonia rates between the June and Decemb
6、er ECB meeting dates is at-4.5bp a 45%chance of a deposit-rate cut to-50bp is priced in the market.We expect the probability of rate cuts to rise if tiering were pre-announced.We initiate a new trade and recommend receiving 5y5y EUR swap.Market expectations for the meeting on 6 June appear to be rel
7、atively low.According to most economists polled by Bloomberg,Draghi is not expected to go further than announcing the details of TLTRO III.Our conversation with a number of clients suggests that this view is broadly shared among investors and we tend to agree with it for a number of reasons(See ECB
8、Preview-No fireworks for more):Q1 GDP was stronger than the ECB expected and addsweight to the view of those arguing that recent weaknesswas partly due to one-off factors and was therefore a softpatch rather than a more enduring slowdown.Staff projections are unlikely to differ significantly fromtho
9、se presented in March.The Governing Council appears relatively divided on boththe economic outlook and the best course of action.Moreover,several ECB members have sounded cold onthe idea of rate-tiering.Policy ammunition is limited and it would make sense forthe ECB to keep its powder dry now,saving
10、 it for anypotential adverse shocks that might come along.Draghis term is coming to an end and the Council maybe reluctant to tie the hands of his successor.All that said,we cant help but feel that by doing so the ECB is running the risk of remaining behind the curve.Will Mario Draghi want to leave
11、the central bank on such a low note?Fig.1:6m change in 5y5y inflation swap(bp)Sources:Bloomberg,BNP Paribas MARKET ECONOMICS|G10 INTEREST RATES|G10 FX|EQUITY&DERIVATIVESFOCUS|EUROPE31 May 2019 Please refer to important information MAR disclosures at the end of this reportLuigi Speranza,Chief Global
12、Economist|Kaushik Banerjee,Head of Global Macro Research|Paul Hollingsworth,Senior European Economist|Eric Oynoyan,G10 Rates Strategist,Europe|BNP Paribas London Branch MARKET VIEW2 31/05/19 How could the ECB deliver a surprise?If the ECB wanted to send a strong signal to markets that it stands read
13、y to do“whatever it takes”to meet its inflation target and to counter any signs of a downturn,then our preferred option would be a pre-announcement or at least stronger language on the possibility of interest-rate tiering.While we have thought for a while that tiering was more likely than not,we bel
14、ieved it was still some way off.We now see a higher risk that a pre-announcement could come sooner possibly in June.It would have a powerful signalling effect(which would probably be the ECBs main aim).By limiting the side effects of lower-for-longer interest rates,it would be the most effective for
15、m of forward guidance without necessarily committing the ECB.It could have a positive impact on banks profitability,enhancing the transmission of monetary policy.It would also buy the ECB the option of cutting rates further into negative territory,if warranted.This,or the expectation of it,could be
16、particularly handy in fending off any potential appreciation of the EUR,if the US economy slows more than currently expected.Whether this on its own is enough to offset the deterioration in the growth outlook and convince markets that inflation is set to move sustainably towards the ECBs 2%target re
17、mains to be seen.But given low expectations for the outcome of Thursdays meeting,a move in this direction might be welcomed.The arguments in favour of more aggressive action are abundant.Among these are:Economic data:The available economic data for Q2suggest that the hard data in Q1 probably oversta
18、ted theunderlying strength of most economies.After a jump inApril,core HICP inflation appears to have re-traced againin May.Beyond monthly volatility which we think is due todistortions related to the timing of Easter,core inflationappears stuck in a close range around the 1%level.Trade war:Trade te
19、nsions have intensified,defyingexpectations that a deal between the US and China wasimminent.We think that the Chinese authorities willrespond with a relatively aggressive package of fiscaland monetary policy measures.But these will take timeto have an effect and probably wont prevent a renewedslowd
20、own in the near term.Brexit:The chances of a no-deal Brexit have risen too,in our view.More eurosceptic rhetoric from futureConservative Party leaders,the polarisation of the Brexitdebate,and a complex interaction between process andtimetable make a disorderly outcome more likely.We putthe risk at 4
21、0%.Inflation expectations:Last but by no means least,market inflation expectations have continued todeteriorate.The 5y5y forward inflation rate,a bellwetherof expected inflation,is close to pre-QE levels.It will behard for the Governing Council to dismiss this signal.What other tools does the ECB ha
22、ve at its disposal?We have previously delved deeply into the ECBs toolbox and concluded that it does have some,albeit limited,measures in its armour.(See Deep Dive ECB Hoping for the best,preparing for the worst.)There are perhaps three other options available at this stage:1)Announcing more generou
23、s TLTRO modalities2)Extending and/or changing forward guidance3)More QETLTRO:In April,the Governing Council appeared to be divided on how to characterise TLTRO III.Some thought the intention was to use it to avoid a funding cliff(pointing to penalties rather than incentives).Others thought it was an
24、 instrument of monetary policy which could be used to ease conditions.Our central case is that the ECB will opt for a compromise,with a system of penalties and incentives linked to lending-based benchmarks,which will result in overall conditions only slightly less generous than those of TLTRO II.Eve
25、n if the ECB decides to make the system more generous,it would do little to alter the big picture substantially,in our view.The credit channel is not impaired,unlike in 2014 when the first round of TLTROs was announced.The key impediment to credit is demand,not supply,constraints.Forward guidance:Th
26、e ECB could always extend the forward guidance horizon again.However,for it to be effective,it would have to be significant ie,until at least December 2020.A shorter extension,say until June 2020,would add little to current market expectations.In fact,it could prove counterproductive for the ECB to
27、acknowledge deteriorating conditions and significant risks,yet only react in a limited way.Another possibility would be to change the forward guidance to allow for the possibility of rate cuts,by mentioning that rates will remain at current levels or lower,until at least a certain date and in any ca
28、se until inflation converges sustainably towards target.Both these options,however,could be detrimental to banks profitability,with potentially negative effects on the transmission mechanism for monetary policy.We doubt therefore that the ECB would want to pursue these options without dealing with t
29、heir potential side effects by introducing tiering.QE:While we think the probability of the ECB re-engaging in asset purchases has undoubtedly risen of late(with private sector assets the most likely),to undertake such a move now would be fairly extreme,in our view.The bar is very high for the ECB t
30、o consider this at the June meeting,even though Draghi might explicitly mention it as a possibility,to convey the ECBs strong message that it is determined to go as far as necessary.Overall,then,while our central case is for next weeks meeting to be limited to an announcement of relatively generous
31、TLTRO III details with dovish language,we cannot discount the possibility that the ECB may surprise markets with something more decisive,in particular with regard to tiering.MARKET ECONOMICS Luigi Speranza,Chief Global Economist|Paul Hollingsworth,Senior European Economist|BNP Paribas London Branch
32、3 31/05/19 Eric Oynoyan,G10 Rates Strategist,Europe|Sam Lynton-Brown,Head of G10 FX Strategy|Edmund Shing,Global Head of Equity&Derivative Strategy|BNP Paribas London Branch Market view Rates:The short end of the curve has priced in 45%probability of a 10bp cut in the deposit rate by December 2019.T
33、he curve between 5y and 10y remains relatively steep,with the 1y forward gaps between 4y and 9y at an average of 18bp.As we think an announcement on tiering has become more likely,we prefer to express our bullish view in the 5y5y part of the curve which remains relatively steep with a good 1y carry
34、and roll on the curve at 18bp.If the ECB does not announce tiering,the EUR 5y5y would be better protected than the front end of the curve,in our view.The examples of Japanese and Swiss rate tiering in 2016 strengthen this view.Indeed,as Fig.2 and 3 illustrate,the initial reaction of a steepening ral
35、ly was followed by a flattening rally.In Japan,the very low level reached by the 10y yield led investors to move further out on the curve,leading to a strong rally on the 30y a few weeks later.Although the highest rolldown on the EUR forward curve is on the 5y1y and 7y1y buckets around 20bp the high
36、er liquidity makes receiving EUR 5y5y more suitable to benefit from a tiering announcement,in our view.Trade:we favour receiving EUR 5y5y swap now at 77bp and on any move to 82bp.1-mth roll profit:1.5bp.Target:50bp.Stop-loss:85bp.Fig.2:Japanese rate-tiering Sources:Bloomberg,BNP Paribas Fig.3:Swiss
37、rate-tiering Sources:Bloomberg,BNP Paribas FX:Risk-reward favours staying short EURJPY,in our view.An outcome at the June ECB in line with our central case is unlikely to have a large impact on the EUR(as we argue in ECB June preview No fireworks).However,we reiterate that risk-reward favours stayin
38、g short EURJPY.In our trade idea portfolio we continue to hold a EURJPY 120 digital put,1-Aug-19 expiry,and are long a EURUSD 1.10/1.18 strangle,funded by a USDCAD 1.2969/1.3796 strangle(expiry 27-Sep-19).The response of the EUR to the June ECB meeting is likely to be a function of two,probably oppo
39、sing factors:(1)the response of eurozone core yields;and(2)the response of eurozone financials and non-core versus core sovereign spreads.To the extent that a strong signal about tiering could weigh on core eurozone yields,all else equal,we also expect it to weigh broadly on the EUR.However,consider
40、ing that it could support eurozone financials and lead to tighter non-core versus core spreads,a signal about tiering will probably largely offset EUR weakness stemming from lower core yields.So,while a strong tiering signal is likely to result in a net weakening of the EUR particularly because BNP
41、Paribas FX Positioning Analysis reveals the market is currently net short the EUR we would not expect the size of the move to be large.Equities:Expectations of ECB tiering of negative deposit rates have evaporated from eurozone bank valuations over the past six weeks.The SX7E bank sector has fallen
42、over 16%from 104 to 86 points,in lockstep with the sharp declines in 10y Bund yields(+0.08%to-0.20%)and in 5y5y forward EUR inflation expectations(now at a low 1.29%).Many of the banks with a high percentage of deposits to pre-tax profits and who thus stand to gain the most in recouped net interest
43、income from any tiering of ECB deposits are French,Benelux and German.However,many of the banks from these countries have been the worst performers in the year to date,down 8%or more against a 1%YTD decline for the SX7E overall.Note that the consensus earnings forecast estimated for 2019 has fallen
44、by over 4%for the banking sector since the beginning of the year.Growth in earning per share is now forecast to be less than 6%this year for the banking sector.While at this point,it is clearly premature to calculate the potential impact on profits from the introduction of tiering,it would neverthel
45、ess send a positive signal that the ECB is prepared to underpin bank lending and reduce the effective penalty on deposits that eurozone banks currently suffer.This is in contrast to their Swiss and Japanese cousins,where central bank tiering of deposit rates was introduced some time ago.-70-60-50-40
46、-30-20-10010T-30T-24T-18T-12T-6T-0T+6T+12T+18T+24T+30T+36T+42T+48T+54T+60T+66T+72T+78T+84T+90Change in rates(normalised to tiering date)JPY 2yJPY 5yJPY 10yJPY 30y-120-100-80-60-40-2002040T-30T-24T-18T-12T-6T-0T+6T+12T+18T+24T+30T+36T+42T+48T+54T+60T+66T+72T+78T+84T+90Change in rates(normalised to ti
47、ering date)CHF 2yCHF 5yCHF 10yCHF 30yAbandonment of currency floorG10 INTEREST RATES|G10 FX|EQUITY&DERIVATIVES 4 31/05/19 Edmund Shing,Global Head of Equity&Derivative Strategy|Viktor Hjort,Global Head of Credit Strategy and Desk Analysis|BNP Paribas London Branch The scope for eurozone bank valuati
48、ons to be re-rated from their current cycle trough of 0.54x 2019s estimated price/book value(P/BV)is substantial based on the prospect of any such boost to earnings.In mid-April,the SX7E bank sector stood at 0.66x P/BV,compared with late 2017 when this stood at a headier 0.90 x.Compare also the curr
49、ent 0.54x for the SX7E to 1.1x for US or Swedish banks(ie,double the relative sector valuation),and 0.80 x for the UK bank sector,and the scope for re-rating becomes evident.Fig.4:SX7E 12-month forward EPS Credit*:EU bank credit is not pricing in much ECB TLTRO fireworks trading in-line with non-fin
50、ancial corporates.Tiered-rates would be a positive surprise.Tiered rates would,all things being equal,benefit bank earnings(equity)and northern European banks(highest excess liquidity)just like a TLTRO,all things being equal,benefits bank funding(credit)and Italian banks(highest funding needs).This