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The disappointing US retail sales figures yesterday weighed on Treasury yields, but the impact on the currency markets appeared to be more muted, as markets also digested dovish comments from ECB President Mario Draghi and Chief Economist Peter Praet.
The ECB press conference was rather uneventful with dovish undertone to it. As expected, the ECB removed the QE easing bias but supplemented it by stating that this was a backward-looking measure and does not necessarily indicate a change in the ECB reaction function. Euro area economy still needed ample amount of stimulus. ECB staff kept the core inflation for 2018, 2019, and 2020 forecast unchanged versus December at 1.1, 1.5, and 1.8%oya, respectively.
However, headline inflation for 2019 was revised marginally lower to 1.4% from a previous forecast of 1.5%; the 2020 number was left unchanged at 1.7%. Draghi was visibly cautious in his language with the focus on avoiding any unwarranted misinterpretation of their communique.
The ECB removed the QE easing bias but caveated it by stating that to be a backward-looking decision. The link between inflation and QE was left in place. We acknowledge risks of the ECB moving slower than expected but for now, keep our baseline call of the first hike in March 2019.
Sub 2Y EONIA is fair with around 40bp of cumulative hike priced by December 2019; stay neutral.
Keep longs in Dec19 EURIBOR in a 1Y wide EURIBOR fly to position for the EURIBOR curve pricing more hikes in 2020 versus 2019.
Focus carry trades in reds EONIA which offer superior risk-adjusted carry characteristics and have limited risk of selling off given our ECB call.
Bund swap spreads are trading expensive vs. fundamental drivers; keep Jun18 Bund swap spreads narrower which is also supported by expected pick up in swapped issuance activity. Courtesy: JPM
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