European Central Bank Monetary Policy Announcement 5 June 2014 Summary On June 5 th, the ECB announced a number of measures to provide additional monetary policy accommodation and to support lending in the real economy. These actions could potentially impact liquidity markets. Most notably, the deposit facility rate has been cut from 0.00% to negative (-0.10%), likely resulting in increased demand for high-quality assets, particularly government securities purchased by money market funds. The ECB also announced targeted credit easing measures to support business lending. This announcement had no immediate impact to Goldman Sachs Asset Management s (GSAM) Dublindomiciled Money Market Funds ( The Funds ), and as always, GSAM will be monitoring markets closely and positioning the funds appropriately in this evolving market environment. Market Backdrop The primary objective of the ECB s monetary policy is to maintain price stability. The ECB aims at inflation rates of just under 2% over the medium term. Recently the euro has become stronger, relative to other major currencies, impeding price stability and economic improvement within the Eurozone by cheapening the cost of imports and hurting export competitiveness. Meanwhile, inflation has remained persistently below 1.0%. As the euro continues to appreciate and a disinflationary environment continues, the ECB s Governing Council has stated a desire to provide further monetary stimulus. The ECB has several potential options to implement monetary easing, most notably using key interest rates (including the main refinancing and deposit facility rate), liquidity injection measures, and quantitative easing through asset purchases. Mario Draghi and other ECB officials have been providing forward guidance to the market that the ECB is not going to be complacent about the risks of a protracted period of low inflation and is ready to act. Given these signals, the market had largely priced in the interest rate cuts. Immediately following this announcement, we saw the euro weaken before rebounding to pre-announcement levels against the dollar and yields offered on short dated euro government bills have tightened by only a couple of basis points. 1
Policy Details We and the market had been anticipating that the ECB would cut key interest rates, given President Draghi s comments during last month s press conference. President Draghi noted that the Governing council was dissatisfied with the current path of inflation, stating that the Governing Council is determined to act, even with unconventional policies. While some in the market had been anticipating liquidity measures, there was not a broad consensus about what those measures would be. The ECB specified these measures and provided a timeline for implementation. The goal of the rate cuts is in part to assist with weakening the euro, which should boost purchasing power, stimulate exports and subsequently, central to this announcement, aim to increase inflation. The liquidity measures announced may be considered as steps to boost lending within the Eurozone. As noted, the ECB announced a combination of interest rate cuts and additional liquidity measures, set forth below: 1. Rate cuts further reduce key ECB interest rates for an extended period of time in view of the current inflation outlook Interest Rate Current Previous Change Main Refinancing Rate 0.15% 0.25% 0.10% Deposit Facility Rate 0.10% 0.00% 0.10% Marginal Lending Facility Rate 0.40% 0.75% 0.35% 2. Introduction of Targeted Long-Term Refinancing Operations (TLTRO)s conduct a series of TLTRO s in the next year. 3. Continue certain monetary accommodation and suspend the sterilisation of the Securities Market Program (SMP) continue a number of existing main refinancing operations (MROs) and long-term refinancing operations (LTROs), but suspend sterlisation of the liquidity injected under the SMP. 4. Prepare for Asset-Backed Securities (ABS) purchases intensify preparatory work related to outright purchases in the ABS market. 2
Potential Implications for Liquidity Investors A unique aspect of this announcement at least historically speaking is the fact that an interest rate set by a major developed market central bank is negative. Although the deposit facility rate is negative, it does not necessarily mean that all short-term securities will trade at negative levels. While the announcement of the deposit facility rate going negative has taken place, the markets have already been pricing a cut of this magnitude into trades over the past few weeks. Rate cut and additional liquidity measures could place continued pressures on government securities, with continued strong demand in the market pushing yields lower. Indeed, downward pressure on yields in high-quality money market instruments has persisted for quite some time against the backdrop of extensive central bank policy stimulus and liquidity programs. In fact, we have seen that happen over the last few years when the ECB has taken past monetary easing steps. Following the ECB s deposit facility rate cut to zero in July 2012, the benchmark yield on overnight repurchase agreements collateralised by high-quality European government bonds has trended lower, and at times dropped below zero. These declines reflect the strain of increased demand on alreadylimited supply, leaving fewer options for investors in euro-denominated liquidity markets. In our view, we are likely to see yields on highly rated short-dated government instruments trade closer to zero, and could even move negatively. Looking Ahead GSAM continues to monitor and manage the Funds, in light of the changing landscape in Europe. Our philosophy has not changed. Our goals remain aligned with those of our fund shareholders. We seek to provide a stable Net Asset Value (NAV) per share money market funds that offer daily liquidity. If a Fund s net investment income on any business day is negative, the Fund will be prepared to implement a mechanism by redeeming shares so that the Net Asset Value per Share remains stable at 1 per Share. We may also need to limit subscriptions under certain market conditions. The Funds will maintain their daily liquidity feature (T+1 or T+0 settlement as applicable), and redemption rights will not be affected. We continue to believe there is value in the diversified approach to liquidity investing that money market funds offer. As always, we are available for questions or to discuss the markets in more detail. For a transcript of the ECB s press conference and Q&A session, please see the following link: http://www.ecb.europa.eu/press/pressconf/2014/html/is140605.en.html 3
Glossary Main refinancing operation A regular open market operation executed by the Eurosystem (in the form of a reverse transaction) for the purpose of providing the banking system with the amount of liquidity that the former deems to be appropriate. Main refinancing operations are conducted through weekly standard tenders (in which banks can bid for liquidity) and normally have a maturity of one week Main refinancing rate The interest rate at which bank reserve requirements are remunerated Deposit facility A standing facility of the Eurosystem which counterparties may use to make overnight deposits at a national central bank. Such deposits are remunerated at a pre-specified interest rate Deposit facility rate The rate paid by the ECB for funds deposited with it overnight by euro area banks Marginal lending facility A standing facility of the Eurosystem that counterparties may use to receive overnight credit from a national central bank at a pre-specified interest rate against eligible assets Marginal lending rate The interest rate on the Eurosystem's marginal lending facility which banks may use for overnight credit from a national central bank that is part of the Eurosystem Securities Markets Programme Interventions by the Eurosystem in public and private debt securities markets in the euro area to ensure depth and liquidity in those market segments that are dysfunctional. The objective is to restore an appropriate monetary policy transmission mechanism, and thus the effective conduct of monetary policy oriented towards price stability in the medium term. The impact of these interventions is sterilised through specific operations to re-absorb the liquidity injected and thereby ensure that the monetary policy stance is not affected Targeted Longer-Term Refinancing Operations An open market operation whereby banks will be able to borrow from the ECB at a fixed rate of 0.10% plus the relevant main refinancing rate at the time of the operation. The first two operations (September 2014 and December 2014) will be limited to 7% of the loan book of the individual bank. In addition to those operations, from March 2015 to June 2016, all counterparties will be able to borrow, quarterly, up to three times the amount of their net lending to the euro area non-financial private sector, excluding loans to households for house purchase, over a specific period in excess of a specified benchmark. All TLTROs will have a maturity of September 2018 but if a bank does not beat the lending benchmark set for them they must return all TLTRO funding by September 2016. Additionally, banks will be able to return TLRTO funding each week following 24 months after the relevant operation Longer-Term Refinancing Operations A regular open market operation executed by the Eurosystem in the form of a reverse transaction. Longer-term refinancing operations are carried out through monthly standard tenders and normally have a maturity of three months Asset-Backed Securities A security that is backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. For investors, asset-backed securities are an alternative to investing in corporate debt 4
This document has been issued by Goldman Sachs International, authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material is not financial research and was not prepared by Goldman Sachs Global Investment Research (GIR). It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed may differ from those of GIR or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates. The information contained herein must not be misconstrued as investment or tax advice. Prospective investors should consult their financial and tax adviser before investing in order to determine whether an investment would be suitable for them. Investment into these funds is not insured or guaranteed by any Government agency, including the Federal Deposit Insurance Company, and is not the same as placing funds on deposit with a bank or deposit-taking company. Although the Goldman Sachs money market funds seek to preserve a stable net asset value per share, it is possible to lose money by investing in the funds. This document has not been delivered for registration to the Registrar of Companies in Hong Kong nor has its content been reviewed by any regulatory authority in Hong Kong. Accordingly, unless permitted by the securities laws of Hong Kong, (i) no person may issue or cause to be issued this document in Hong Kong, other than to persons who are "professional investors" within the meaning of the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) and any rules made thereunder or in circumstances which do not constitute an offer or sale of shares in the name of company to the public in Hong Kong for the purposes of the prospectus requirements of the Companies Ordinance (Cap. 32 of the Laws of Hong Kong); and (ii) no person may issue or have in its possession for the purposes of issue, this document, or any advertisement, invitation or document relating to the shares in the name of company, whether in Hong Kong or elsewhere, which is directed at, or the contents of which are likely to be accessed by, the public in Hong Kong, other than with respect to the shares in the name of company which are intended to be disposed of only to persons outside Hong Kong or only to "professional investors" within the meaning of the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) and any rules made thereunder. This material has been issued or approved for use in or from Hong Kong by Goldman Sachs (Asia) L.L.C. This material has been issued or approved for use in or from Singapore by Goldman Sachs (Singapore) Pte. (Company Number: 198602165W). Confidentiality No part of this material may, without GSAM s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient. 2014 Goldman Sachs. All rights reserved. Ref 151289 5