The ECB turns slightly less dovish with market attention now shifting to the Fed meeting
The ECB was more optimistic regarding the euro area, upgrading its outlook for growth and inflation (see page 2). Mr. Draghi noted that the downside risks have become less pronounced.
Moreover, the recovery has broadened across sectors and countries (see graph). As a result, the likelihood of the ECB increasing monetary policy accommodation has declined considerably.
Mr. Draghi confirmed that there had been no discussion of QE tapering, reiterating that a convincing upward trend in underlying inflation is not yet evident (currently at 0.9% for 3 consecutive months), combined with the absence of wage pressures.
Overall, we expect the ECB to signal its intention to slow further its asset purchases (€60bn per month from April 2017 to December 2017), in Q2/Q3 2017, and to end them by mid-2018.
Political uncertainty in the euro area, if escalated, could pose challenges to this assessment. Attention is focused on the Dutch general elections (March 15). Assuming support for the anti-EU anti-immigration PVV is larger than polls suggest (second party with 13% of the votes), uncertainty could increase regarding the outcome of the French election (April/May).
The Fed is expected to increase the target for the Federal funds rate by 25 bps to 0.75% - 1.00% on Wednesday, supported by the strong February labor market (nonfarm payrolls of 235k vs a 12-month average of 196k).
Investor attention will be on the Committee’s interest rate forecasts for 2017 (currently: 3 hikes) and 2018 (currently: 3 hikes to 2.25%), with risks tilted towards further rate increases.
Global equity markets were broadly flat ahead of major policy events including the Fed, BoE and BoJ meetings, the Dutch general elections and UK Government triggering Article 50. Euro area banks overperformed on the back of higher rates (+3.8% wow).
Indeed, Government bond yields continued to rise, on the back of expectations for a Fed hike on March 15 and lower risks to the euro area economic and political outlook. The US Treasury 10-year yield increased by 10 bps on a weekly basis to 2.58%, and the German 10-year Bund yield was up by 13 bps to 0.49% (the highest since January 2016).
Oil prices declined abruptly, on the back of continued increases in US oil inventories. Specifically, Brent declined by 8.3% on a weekly basis to $47.5/barrel, and industrial metals were down (-2.4%) due to rising interest rates.