The moves once Mario Draghi hinted that the ECB had reached the lower bounds on interest rates were dramatic to say the least.
The initial rally in the DAX was the right one, in my opinion, as the ECB went above and beyond expectations, which was what my tactical idea was premised on. In effect, the ECB have totally changed tactics and shifted from targeting bond yields, and indirectly the euro, to one of easing financial conditions and channelling credit into the real economy.
With inflation expectations not far from record lows, the ECB are effectively paying banks to take up liquidity, while they get the secondary kicker of also being paid by consumers to on-lend. The measures announced have moved the goalposts from indirectly targeting a weaker euro, and in turn increasing competitiveness and domestic demand, to compel the commercial banks to extend credit and hopefully boost inflation. European banks have and should continue to outperform from here.
The failure to announce a two-tiered system on excess liquidity was what really hurt the trade, and had this been announced (as expected) then equities would have undoubtedly stayed bid and enjoyed a strong session. In fact, given the ECB will not lower the deposit rate further could actually be construed as a positive for banks net interest margins, especially given banks are being paid up to 40 basis points to borrow from the ECB’s new Targeted Long-term Refinancing Operation (TLTRO). The move higher in the euro was actually the real negative for the DAX, and in theory if the ECB are moving away from interest rates the impetus to sell EUR has diminished.
Waiting for the price to close the session above 9890 was clearly the correct way to have traded this event and while 10400 was always a target, it was unlikely to be achieved in one session. Certainly for those long corporate credit you would feel that Mario Draghi is the boss, especially after we have seen credit spreads collapse.
The upshot is that what Mario Draghi has announced indicates that the ECB have effectively exited the global ‘currency war’ that it entered in June 2014. All eyes are now focussed on the take up at the first of four liquidity operations (TLTRO) in June, as well as the ECB’s survey on bank lending on (19 April). It will also be interesting to look out for signs that companies are planning to increase capital spending.
This week, traders get to hear from the Bank of Japan and the Federal Reserve who will both be enthused by what they have seen from the bounce in risk assets and financial conditions of late. A more upbeat tone from the Fed would not be a surprise given the improvement in global financial conditions and the domestic economy. Short positions in interest rate markets (Eurodollar and Fed Fund Futures), especially the September and December contracts look attractive given the current pricing structure.