ECB policy: how to taper without causing a tantrum?

Transcription

1 Europe Insights Monthly update on European Markets August 217 ECB policy: how to taper without causing a tantrum? Summary In the Spotlight. The European Central Bank (ECB) has already reduced monthly purchases under its Asset Purchase Programme this year (by 2bn to 6bn in April). However, the ECB s communication has so far avoided any reference to tapering, which may have provided markets with the perception of an auto-pilot policy tightening. Indeed, the ECB is unlikely to change its forward guidance as doing so may result in an abrupt tightening of monetary conditions, as well as currency volatility. Read more on page 2 & 3 ECB s QE stock will increase by end 217, reaching 21% of Eurozone GDP, close to the Fed s and BoE s levels As of % GDP 3% 25% 2% 15% 1% 5% % 24% Forecasts Dec % 21% ECB US Fed BoE Sources: Reuters Datastream, Central Banks, Consensus Economics, July 31st, This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target.

2 Europe Insights August 217 In the Spotlight. ECB policy: how to taper without causing a tantrum? The ECB has already cut its monthly asset purchases this year by 2bn to 6bn in April (see figure 1). However, the bank s communication avoids any reference to tapering, as it may have given markets the perception of an auto-pilot tightening of policy. The ECB is also unlikely to change its forward guidance as doing so may result in an abrupt tightening of monetary conditions as well as currency volatility. Figure 1 ECB already reduced its QE in terms of flows Net purchase per month Bn June 216: CSPP s launch Sovereign Supranationals Agencies/Regionals Corporates Covered bonds ABS Sources: European Central Bank, Reuters Datastream as of July 31 st, 217 A constrained asset purchase programme The ECB s asset purchase programme (APP) includes two constraints: I. the capital key (1) ; II. the 33% issue/issuer threshold. These two constraints imply that the ECB will have difficulties in maintaining the pace of 6bn worth of monthly purchases beyond December 217 without some degree of flexibility within the rules. Currently, the ECB s purchases are over-allocated to Italy, France and Spain, and under-allocated to Germany. The Corporate Sector Purchase Programme (CSPP) is becoming an increasing share of the APP stock. Meanwhile, the ECB will try to avoid giving the perception that tapering QE is a result of existing constraints. In his opening speech at the central banks Annual Forum in Sintra on 27 June, ECB President Mario Draghi said as the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments not to tighten the policy stance, but to keep it broadly unchanged. A very long road towards policy normalisation Roughly mimicking the Fed s policy normalisation, the ECB would continue reducing its QE purchases in January 218, before ending the programme in October 218. They would then start hiking the deposit rate just over a year later in December 219, while keeping on reinvesting its maturing bonds. Finally, balance sheet normalisation would occur two years later in Q4 221 (see figure 2 on page 3) (2). While this roadmap may give some indication around the ECB s course, it is far from certain. The ECB has always made it clear that its QE programme can be extended or enhanced if required. The ECB also has to find the right policy mix across very different economies, from those with relatively high inflation and tight labor markets (i.e. Germany, Austria, Netherlands) to those with low inflation and financial vulnerabilities (Italy, Portugal and to a lesser extent Spain). On the one hand, the situation in Germany, as expressed by the Bundesbank, advocates a tapering of QE and deposit rate hikes. On the other hand, financial vulnerabilities in the eurozone periphery suggest these economies would like to avoid any significant tightening of financial conditions. (1) The capital key constraint sets asset purchases per country equal to the participation in the European Central Bank s capital, which is determined by population and GDP in equal parts (26.3% for Germany, 2.7% for France, 18% for Italy, 12.9% for Spain, 5.9% for Netherlands, 3.6% for Belgium, 2.9% for Austria, 2.5% for Portugal, 1.8% for Finland, 1% for Slovakia, and less than 1% for the other Eurozone countries) (2) Based on the assumption that the US Federal Reserve Bank would start its balance sheet normalization in 4Q 217 The views and opinions expressed herein are subject to change at any time. These views may not necessarily indicate current portfolios' composition. Individual portfolios managed by HSBC Global Asset Management primarily reflect individual clients' objectives, risk preferences, time horizon, and market liquidity. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target. The content of this page is not intended as an advice or recommendation to buy or sell any sector or financial instrument. 2

3 Europe Insights August 217 In the Spotlight. ECB policy: how to taper without causing a tantrum? Positively, however, these financial vulnerabilities have receded recently on the back of the ongoing consolidation of the Italian, Portuguese and Spanish banking sectors (3). The ECB is increasingly placing pressure on European banks to set up a two-year funding plan for recapitalization, non-performing loans sales and securitisation. Finally, harmonised regulation to support secondary markets for non-performing loan in the region should take place in 1Q 218 (4). Against this backdrop, the ECB may be able to withdraw its exceptional policy measures, including negative rates and bond purchases in a very gradual manner. Figure 2. The Fed s policy normalization process a blueprint for the ECB? Fed Funds rate % Nov. 28 QE starts June 213 QE "Tapering" discussions Sept 213 "Tapering" is delayed Jan.-Oct.214 "Tapering" Nov Aug 217 Reinvestment maturing bonds Dec 215 First rate hike Fed's total assets USD billion Sept 217: B/S normalisation? Sources: US Federal Reserve Bank, Reuters Datastream as of July 31 st, 217 (3) i.e. Europe Insights July 217: Italian banks: a solution aligned to risks (4) European Commission Development of secondary markets for non-performing loans and distressed assets - June 217 European Equities. Sector positioning: Sector Weight (1) Rational Commercial Services & Supplies Banks Many companies in the sector offer sustainable growth and attractive valuations. Preference for eurozone retail banks (ex-germany). The sector is bouncing back thanks to higher market interest rates and the regulatory environment has softened due to disagreements over a finalized global framework. The sector is better capitalized than ever before. Capital Goods Continued growth momentum in the sector is favorable even though European capital goods have already outperformed significantly on the back of strong consensus earnings upgrades. Materials Valuations are low and underlying fundamentals supported by synchronized global economic recovery. Telecoms Undervaluation, defensiveness and the potential for M&A and consolidation. Consumer Durables & Apparel Household & Personal Care The sector is composed of very expensive luxury good companies. Slightly due to valuations. We believe that the sector as a whole is expensive, particularly in an environment of rising inflation. Diversified Financials Utilities Consumer Staples Unattractive valuations. Sources: HSBC Global Asset Management/Factset/MSCI as of 8 August 217 to counterbalance our overweight position in banks. We went underweight after recent outperformance of the sector, rising interest rates and ongoing political and regulatory risk. (1) Position of European strategy in terms of key Overweight () and Underweight () versus MSCI Europe. The content of this page is not intended as an advice or recommendation to buy or sell any sector or financial instrument. The views and opinions expressed herein are subject to change at any time. These views may not necessarily indicate current portfolios' composition. Individual portfolios managed by HSBC Global Asset Management primarily reflect individual clients' objectives, risk preferences, time horizon, and market liquidity. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target. The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. 3

4 Europe Insights August 217 Euro Fixed Income. Outlook & overall portfolio positioning In July. The market was very quiet with very low volatility. The main movers were higher oil prices and the rise of the euro against the other major currencies. Rates market were little changed on the month with 1Y bund slightly up at.54%, Italian and Spanish sovereign outperforming Germany. European credit was again well bid, with Investment Grade indices 9bps tighter on the month. Spreads moved in a very narrow range to reach the tightest level of the year so far. The performance of European credit was evenly split across the different sectors, Automobile and Corporate hybrid were the underperformers while Basic resources and Subordinated financials were the outperformers. Outlook. Valuations in the credit market with increasingly low risk premiums and a decline in volatility prompt us to be cautious. Senior corporate credit is expensive now and more sensitive to a rise in sovereign interest rates, as proven in June. However some segments seem still attractive in our view, especially subordinated debt issued by both financial and non-financial issuers. Financial sectors in particular benefit from still robust credit quality, due to regulators rigorous requirements in terms of the quantity and quality of equity. The last difficult cases (small peripheral banks) are being resolved. We maintain exposure to short corporate bonds which are less correlated to government bond yields. The credit quality of the vast majority of issuers remains solid. We believe default rates will stay low around 2% as the cyclical economic picture and corporate profitability does continue to look healthy. The ECB's intervention remains a positive technical factor. We remain underweight duration as the actual level is still far from our equilibrium level (.9%), while tactically adjusting our position in line with sovereign bond yields. Our central scenario remains a gradual normalisation of interest rates in the medium term. Data watch: 8 August 217 Indicator Date Actual Consensus Previous data PMI composite July GDP quarterly, % QoQ Industrial production % YoY 2Q A.6%.6%.5% May 4.% 3.5% 1.2% Unemployment rate June 9.1% 9.2% 9.2% Trade balance, monthly EUR Bn (12Mth cumulative) Retail sales % YoY Inflation: - Headline CPI, % YoY Inflation: - CPI core (1), %YoY ECB Refinancing rate June June 3.1% 2.5% 2.4% Analysis The eurozone composite PMI declined slightly in July, from very robust levels held in 2Q. The index remains well in expansionary territory and still above its long-term average. Eurozone real GDP growth rose.6% qoq in 2Q, up from.5% in 1Q 217. This drove the year-on-year rate of expansion to 2.1%, the highest in five years. The full Eurozone 2Q GDP report will be released on 16 August. Eurozone industrial production surprised to the upside, up to +4.% yoy the fastest rate of expansion since August 211, with gains broadly spread across sectors. The June eurozone unemployment rate dropped slightly more than expected to 9.1%, reaching the lowest level since February 29. All of the big four eurozone economies saw their unemployment rates decline, with Germany dipping to an all-time low of 3.8%. On a 12-month cumulative basis, the trade surplus (ex eurozone) has kept on declining from the record level held in December 216 ( 266bn, or around 2.5% of eurozone GDP). This recent declining trend stems from an acceleration of imports (4.8% yoy) relative to exports (3.9% yoy). Eurozone retail sales continued to surprise to the upside in June on the back of improving consumer confidence, higher employment and favorable credit conditions. July 1.3% 1.3% 1.3% Eurozone headline inflation stabilized, while core inflation, the ECB's preferred measure, picked up again, leaving the year-to-date average July 1.1% 1.2% 1.1% at 1% yoy (against.8% in 216 and in 215). July 2.%.%.% Deposit rate -.4% -.4% -.4% improved or better-than-expected data on month-on-month/quarter-on-quarter basis worsened or below-expectations data on month-on-month/quarter-on-quarter basis unchanged data or in line with expectations on month-on-month/quarter-on-quarter basis As expected, the ECB kept its policy on hold. Concerning the 6bn a month Asset Purchase Programme (APP), ECB s President Draghi pointed to a renewed discussion in the autumn along the new staff projections (to be released in September). Draghi also reiterated that inflation is not where we want it to be, therefore requiring persistence with monetary policy accommodation. Meanwhile, he stated the recent strength of the euro has received some attention although hadn t been enough to worry the Governing Council. (1) Eurozone CPI Core is CPI excluding energy, food, alcohol & tobacco F: Final estimate A: Advanced estimate Sources: Bloomberg, Datastream, Eurostat, HSBC Global Asset Management, as of 8 August 217. The content of this page is not intended as an advice or recommendation to buy or sell any sector or financial instrument. The views and opinions expressed herein are subject to change at any time. These views may not necessarily indicate current portfolios' composition. Individual portfolios managed by HSBC Global Asset Management primarily reflect individual clients' objectives, risk preferences, time horizon, and market liquidity. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target. The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. 4

5 Europe Insights August 217 Important information The contents of this document may not be reproduced or further distributed to any person or entity, whether in whole or in part, for any purpose. All non-authorised reproduction or use of this document will be the responsibility of the user and may lead to legal proceedings. The material contained in this document is for general information purposes only and does not constitute advice or a recommendation to buy or sell investments. Some of the statements contained in this document may be considered forward looking statements which provide current expectations or forecasts of future events. Such forward looking statements are not guarantees of future performance or events and involve risks and uncertainties. Actual results may differ materially from those described in such forward-looking statements as a result of various factors. We do not undertake any obligation to update the forward-looking statements contained herein, or to update the reasons why actual results could differ from those projected in the forward-looking statements. This document has no contractual value and is not by any means intended as a solicitation, nor a recommendation for the purchase or sale of any financial instrument in any jurisdiction in which such an offer is not lawful. The views and opinions expressed herein are those of HSBC Global Asset Management and are subject to change at any time. These views may not necessarily indicate current portfolios' composition. Individual portfolios managed by HSBC Global Asset Management primarily reflect individual clients' objectives, risk preferences, time horizon, and market liquidity. The value of investments and the income from them can go down as well as up and investors may not get back the amount originally invested. Past performance contained in this document is not a reliable indicator of future performance whilst any forecasts, projections and simulations contained herein should not be relied upon as an indication of future results. Where overseas investments are held the rate of currency exchange may cause the value of such investments to go down as well as up. Mutual fund investments are subject to market risks, read all scheme related documents carefully. We accept no responsibility for the accuracy and/or completeness of any third party information obtained from sources we believe to be reliable but which have not been independently verified. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain for making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided as an "as is" basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively 'the MSCI Parties') expressly disclaims all warranties((including, without limitation, all warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Copyright HSBC Global Asset Management Limited 217. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of HSBC Global Asset Management Limited. Issued by HSBC Global Asset Management (Hong Kong) Limited 5