Markets await policy signals from the incoming Trump Administration
The ECB is expected to remain on hold on Thursday. However, according to the minutes of the December ECB meeting, there was broad support among officials for decreasing monthly QE by €20bn to €60bn starting from April 2017, due to the strengthening of the euro area economic recovery.
Indeed, business and consumer surveys have increased and 2017 GDP consensus forecasts are improving (see graph). Assuming no major political turmoil following the French and Italian elections, the ECB could signal in mid-2017 its intention to begin slowing further its asset purchases (January 2018) and end them in mid-2018 (e.g. gradually reducing its bond purchases by €10bn per month).
Against the backdrop of a gradually improving economic outlook, 10-Year Bund yields increased by 4 bps to 0.34%. Upside pressures on German yields will continue from smaller amounts of ECB purchases (and the option to buy bonds at/below the Deposit Facility Rate of -0.4% and in the 1Yr-2Yr range, effectively from January), higher inflation rates and strong GDP growth.
10-Year US Treasury yields declined by 2 bps to 2.40%, and have reversed circa 25 bps of their 90 bps post-US election increase. It is worth noting that real yields have led the decline, with inflation breakevens remaining broadly unchanged (see graph). However, we expect 10-year UST yields to end 2017 higher than forwards (2.68%) are pricing as: i) US real GDP growth will receive a boost in H2:17/H1:18 from lower taxes and higher spending; ii) PCE inflation rises towards 2%; and iii) the Fed proceeds with 2-3 rate hikes.
Gilt yields declined due to hard-Brexit worries, ignoring positive economic news, including Governor Carney’s comments that recent data is consistent with BoE GDP forecast upgrades.
Increasing signs that PM May will seek higher sovereignty at the expense of Single Market access sent the British Pound to a 3-month low against the USD. The GBP will remain under pressure (despite a relief-rally on Tuesday, as PM May said that the British Parliament will have to vote on the Brexit deal, before it comes into force) and may fall further when the UK Government activates Article 50 of the Treaty of the European Union.
Italian assets also came under selling pressure on Monday, following the downgrade of the Italian Government by the DBRS from A to BBB+ (with the other 3 rating agencies rating Italy at BBB). This action will raise the haircuts imposed on Italian Government Bonds when used as collateral to receive ECB liquidity.
Global equities were broadly flat during the past week, with the FTSE100 (benefiting from a weaker GBP) and EM overperforming (mainly due to aggressive easing by the Central Bank of Brazil). Mr. Trump’s Inauguration speech (on 20th January) and the evolution of Q4:2016 earnings season (see Table on page 3) will shape investors’ risk appetite in the short term.