Kitchen sink full of medicine

The ECB has taken a six-pronged approach to the latest policy decisions. This is their “kitchen sink moment”, similar to the BoJ back in late 2013 when they went all in with news and bigger measures to tackle deflation. The move has initially knocked one big figure from EURUSD. After December disappointed in the size and scope of the measures announced, the markets were naturally reluctant to push the currency lower. Furthermore, the risk averse environment that has prevailed through a fair proportion of the year to date has also in part benefited the single currency. After all, FX is always a relative game and the dollar itself has been push lower by the pricing out of rate hike expectations.

The ECB has acted on rates (main, deposit, marginal lending), increased asset purchases to EUR 80bln a month, widened these assets to investment grade non-bank corporations and introduced four more long-term refinancing operations (TLTRO II). In other words, they pulled pretty much all of the levers available to them.

The currency reaction is understandable, given the caution that prevailed ahead of the decision. The interesting reaction is in the bond markets. German 2 year initially 4bp higher, 10 year was initially broadly flat but is now falling, together with greater falls in peripheral market yields. Bond buying should push yields (even) lower, but if/when these actions impact the economy, then yields should rise on pricing of higher inflation and interest rates in the future. So read into this what you will.

As for equities, they are naturally higher just on the ECB exceeding expectations. But you need to stand back from all this day to day noise to see the mad world we are now in. The ECB is penalising around 40% of funds that eligible institutions park with it and this proportion has been rising since the policy of negative rates started. This policy is meant to push banks to lend funds out, rather than sit on them. To do this, banks have to take on more mis-priced risk. Remember, we’re still in the aftermath of a credit crisis, which is all about excess and mis-priced lending (c.f. US sub-prime etc.). The absurdity of it all reflects the desperation of central banks to put underlying economies back on a path of normality, leaving aside the fact that the medicine is the thing that put us here in the first place.