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Following last week’s shift in Fed rhetoric, this week’s ECB meeting saw a lower emphasis on its forward guidance. Indeed, Draghi referred to it as an expectation, rather than a commitment, and subsequent press reports left open the question of a sequencing of rate hikes and ending QE.
Our analysis of TLTRO take-up suggests there is scope for further take-up across countries; we expect an allotment of around €70bn with upside risk, with moral suasion from the ECB to discourage their use for carry trades and/or liability management.
In the Euro area, the ECB press conference supports higher yields and steeper curves: enter 7s/15s Germany steepeners.
The ECB tweak its forward guidance and frame the policy debate for the coming months. One dimension to this is about the macro outlook: balancing the signal from low core inflation against the signal from rapidly declining unemployment. A second dimension is about the eventual exit: end QE before raising rates, as currently planned, or reverse the sequence to provide some insurance against political and banking risks through ongoing QE.
On the macro side, we expect the GDP forecast to be revised modestly higher (especially for this year), while headline inflation is likely to be revised up 0.7%-pts to 1.9%oya for this year.
Hold 2Yx2Y/15Yx5Y EUR swap curve steepener. We fade hiking priced in H1’18 and stay long Jun’18 ECB OIS. Hold 2s/10s weighted bear steepener and bull flattener.
Hold Bund/Buxl swap spread curve flattener. Hold 2Yx2Y EUR/USD cross currency basis and Sep17 FRA/OIS wideners as hedges against French political risks. In vol, stay short gamma at the front end and long Jun17 Bund gamma.
Intra-Euro area, we stick with a cautious stance, focusing on cheap hedges against further risk aversion. Add 10s/30s Italy steepeners vs. Spain to existing 10s/30s France/Germany box steepeners.
