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Lagarde’s 'Whatever It Takes' ECB

By Swissquote Ltd (Peter Rosenstreich)BondsJul 04, 2019 12:38
Lagarde’s 'Whatever It Takes' ECB
By Swissquote Ltd (Peter Rosenstreich)   |  Jul 04, 2019 12:38
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Unorthodox monetary policy since the post-financial crisis has always generated controversy. To ensure economic and financial stability during the financial crisis central banks expanded their tools to deal with extreme risks. Since these tools are generally outside the scope of traditional modern economic theory, tactics such as negative interest rates and quantitative easing are accused of distorting asset markets.

The ECB manages three key interest rates main refinancing operations (MRO), the rate on the deposit facility and marginal lending facility rate. In times of calm, it’s the deposit facility at -0.40% which captures the market attention although the main refinancing operation is used most often to provide liquidity into the banking system.

With monetary policy stuck at extremely loose levels, the direction of policy action is less clear. Historically, with all things being equal, the direction of inflation was the primary input for deciding policy mix. Higher inflation expectations would trigger higher policy rates (and vise-versa). With ECB policy still at extraordinary positioning, would suggest that policy setting moving forward have a higher discretionary aspect. Hence, ECB chief succession is of critical importance.

The ECB has moved towards a more dovish bias as the regional economic outlook has deteriorated and inflation expectations are fading. Draghi’s recent comments suggest significant probably of monetary policy action in July. After that point, the Governing Council will not meet again until September. One can argue the ECB efforts to achieve their price stability mandate have been exhausted and the next policy direction will be based on the personal philosophy of the primary decision maker.

To take over the ECB helm, early bets were skewed towards Jens Weidmann the Bundesbank president. Given his hawkish stance and German economic lean, we would anticipate a shift in ECB predisposition (i.e. less extreme measures benefiting low growth EU nations). However, Christine Lagarde is now in the pole position to head the ECB. Lagarde with her strong personality and solid global republicans will likely continue Draghi policy, which supports weaker peripheral European nations. Her appointment, which still needs to be approved by the European Parliament, would likely bring a new prescription of accommodative monetary policy. A policy package mix of negative Interest rates, new TLTROs, and asset purchases is coming with Lagarde at the head of the ECB.

Global yields have fallen expectation of weak economic outlook and anticipating additional ultra-loose monetary policy. Yet yesterday saw European yields drop sharply as Lagarde’s historical preference for stimulus made an impression on bond markets.

Across the continent, short-end yields are now below zero. German 10 yr yields fell to a new all-time low at -0.397 (just a sliver above ECB own deposit rate) while France's 10 yr yields reached -0.10. While bondholders are being crushed, we should see further rotation into SMI and global equity markets. The mad search for yields has been reignited.

Disclaimer: While every effort has been made to ensure that the data quoted and used for the research behind this document is reliable, there is no guarantee that it is correct, and Swissquote Bank and its subsidiaries can accept no liability whatsoever in respect of any errors or omissions, or regarding the accuracy, completeness or reliability of the information contained herein. This document does not constitute a recommendation o sell and/or buy any financial products and is not to be considered as a solicitation and/or an offer to enter into any transaction. This document is a piece of economic research and is not intended to constitute investment advice, nor to solicit dealing in securities or in any other kind of investment.

Although every investment involves some degree of risk, the risk of loss trading off-exchange forex contracts can be substantial. Therefore if you are considering trading in this market, you should be aware of the risks associated with this product so you can make informed decisions prior to investing. The material presented here in not to be construed as trading advice or strategy. Swissquote Bank makes a strong effort to use reliable, expansive information, but we make no representation that it is accurate or complete. In addition, we have no obligation to notify you when opinions or data in this material change. Any prices stated in this report are for information purposes only and do not represent valuations for individual securities or other instruments.

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Lagarde’s 'Whatever It Takes' ECB

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Lagarde’s 'Whatever It Takes' ECB

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