Going into today’s call we positioned ourselves to be long the EUR/USD, positing that Draghi would likely underwhelm the market’s loft expectations for easing (see yesterday’s Reiterating Our Long GLD and FXE Position Into The ECB Policy Statement; and (5/23) Buying the Euro (FXE). Our call appears to be the right one: the cross maintains our $1.35 support level and bounced higher following Draghi’s press conference as equities rose in tandem.
While the main interest rates were trimmed nearly in line with consensus (44 of 50 economists baked in a negative deposit rate with 56 of 58 expecting a cut in the benchmark rate), no QE was announced. Given, we think the setup portends a dovish monetary response by the Federal Reserve as growth surprises to the downside, which should continue to support our weak USD, strong EUR call.
We applaud Draghi’s issuance today of a new lending program to the “real” economy, named the Targeted Longer Term Refinancing Operations (TLTRO). While we witnessed little to no transmission to the “real” economy from the former LTRO programs, if in fact the TLTROs can be conditionally strong on lending requirements, we’re bullish on them for the Eurozone’s growth outlook. That said, we don’t see the program shifting either the European equity or currency markets in a material way.
Draghi offered a confident tone that today’s interest rate policies moves and the TLTROs could boost the inflation rate to the target of 2.0% (his main concern going into the meeting), yet he did not rule out a potential asset-purchase program as one of several non-traditional alternatives should today’s measures not achieve inflation targets. Interestingly, the Bank’s staff inflation forecasts see inflation only inching up to 1.5% at the end of 2016 – we expect Draghi to keep his back pocket loaded with QE should he need to manufacture higher inflation.
What was delivered in cuts?
- Benchmark Rate: cut from 0.25% to 0.15% (0.10% est.)
- Marginal Lending Facility: cut from 0.75% to 0.40% (0.60% est.)
- Deposit Facility: cut from 0.0% to -0.10% (-0.10% est.)
Draghi on the terms of the TLTRO?
- TLTROs will begin issuance in SEPT and DEC of this year with a maturity in SEPT 2018
- Draghi says intent is to improve credit to the private (non-financial) sector with the ultimate view of price stability that transfers to real economy
- There are provisions that require additional disclosure on use of TLTRO funds; for example, if not compliant with lending to the “real” economy, institution will be forced to repay entire loan after 24 months
- TLTROs not to be used for loans to households for house purchase
Draghi Hints that QE-type Program Targets Asset Backed Securities (ABS)
- Simple (no CDS, CDS squared, CDOs etc.)
- Real (non-derivatives)
- Transparent (all market participants easily understand)
Updated ECB Staff Macroeconomic Projections Head to the Downside
- Growth Projections: in 2014 +1% vs +1.2% seen in March; 2015 +1.7% vs +1.5%; 2016 +1.8% unchanged from March.
- Inflation Projections: in 2014 +0.7% vs +1% seen in March; 2015 +1.1% vs +1.3%; 2016 +1.4% vs +1.5%; 2016 Q4 +1.5% vs 1.7%.