Draghi delivered on the market’s expectations for a rate cut today, the first since July 2012. At today’s “away” press conference in Bratislava, Slovakia the ECB cut the main refinancing rate by 25bps to 0.50%; cut the marginal lending facility rate 50bps to 1.00%; and kept the deposit facility rate unchanged at 0.00%. (Click here to read Draghi’s prepared remarks). The cuts had “prevailing consensus” from the council and a future cut to the deposit rate was not ruled out by Draghi.
Draghi had little to say about the precipitous drop in inflation (to 1.2% in APR Y/Y from 1.7% in MAR) beyond the impact of lower energy prices and an earlier Easter shift – all of which doesn’t exactly add up. Beyond the cut Draghi extended non-standard measures into at least Q2 2014, but gave little context on how the Bank may improve the clogged credit conditions and support the region beyond the OMT. In large part equity markets and the EUR/USD were down on the announcement (as we predicted), as the market once again digested how little Draghi can do to turn around weak underlying fundamentals.
On what Draghi can’t directly influence, we'll highlight: Eurozone Unemployment remains at an all-time high of 12.1% (with youth unemployment across the periphery at 50%+); PMIs remain worrisome; and loans to households and corporations continue to fall (to name a few).
That said, our call remains that it will still pay to play Draghi’s OMT put. The disconnect between the capital markets and underlying fundamentals remains disconcerting, however until more meaningful risks arrive, we will acknowledge the trend.
On the positive front:
- Cyprus is clearly rear view
- Slovakia is out of sights (for now at least)
- Italy has formed a coalition government and is in discussion about its future budget
- Domestic deposits in most countries are rising
- Target 2 Balances continue to go down, and stabilize
- The European Commission (alongside the key Eurocrats) remain dovish and positioned to extend deficit targets (in Spain and France in particular) and lessen the bite of austerity
- There’s an improved risk picture, with 10YR sovereign yields across the periphery at some of their lowest levels in years (Italy’s at 3.84% and the 2YR is at an all-time low of 1.07%!)
- Bond issuance YTD has largely been priced at lower yields even for the region’s “troubled” countries.
We expected the EUR/USD to slip on a rate cut from the ECB. Keith opportunistically covered our Real-Time short position in the EUR/USD via the etf FXE this morning. Our critical quantitative lines on the EUR/USD are outline in the chart below. Beyond immediate term TRADE support of $1.29 we do not see any meaningful support until around $1.22.
Draghi on Austerity
Diverting from his normal script, Draghi discussed the improvements in the fiscal landscape, noting that the average government deficit declined from 4.2% of GDP in 2011 to 3.7% in 2012 and the average government debt rose from 87.3% to 90.6% of GDP. As usual he encouraged countries to keep up their structural reforms, but alongside the commentary showed the limitations of the Bank to have any influence over the fiscal states. This supports our thinking that while Draghi may have influence over the capital markets, he has little influence over reforming the underlying economies of 17 distinct nations.
Click here for a video on the launch of the new €5 note.