Market Commentary: ECB driving the markets

It goes without saying that yesterday the main driver of asset returns was the ECB monetary decision, which in many ways was historic. It also reassured the markets that Draghi’s older commitment to do “whatever it takes” was more than a rhetorical attempt to boost investors’ confidence. 

As it was widely covered by media, the measures taken yesterday include a 10 bps reduction of the main interest rate, cutting the deposit rate to -0.10%, removing the sterilization of the Securities Markets Program (i.e. not mopping the liquidity created via bond purchases), maintaining the unlimited funding under its main refinancing operation and introducing a long term funding facility targeted towards increasing lending (TLTRO).

Hence, while taking steps to maintain adequate bank liquidity in place, the ECB is looking to discourage the banks from parking the excess cash with the central bank and instead channel this towards corporates via lending so as to bolster economic growth. What’s more, Draghi also showed that more measures might follow as the bank is currently working to prepare for purchases of Assets Backed Securities (ABS).  Naturally, following the logic of TLTRO, these securities would have to be backed by loans.

The twist in policy comes after earlier measures, most notably the asset-buying program and the long-term funding program (dubbed LTRO), were generally unsuccessful in reinstating credit growth; instead, the banks appear to have used this new funding as cash buffers (often parked at ECB) or as a profit increasing opportunity by investing them in assets such as higher yielding sovereign bonds.

Thus, the TLTRO is probably the most significant step from the measures announced yesterday. However, the first operation of this kind is due to take place not sooner than September, when banks will be able to apply for funding amounting to maximum 7% of their lending to euro-area corporates; a similar exercise will follow in December 2014, whereas quarterly from March 2015 to June 2016, ECB will hold new TLTROs but this time the funding will depend on the value of loans extended since May 2014.

Yesterday markets appeared content with the results of the monetary policy meeting, with the European equities growing and peripheral sovereign bonds trending upwards. Emerging markets also joined the uptrend with the notable exception of Brazilian stocks where the Central Bank’s minutes pointed to subdued growth outlook. 

Nevertheless, the financial equities and bonds are expected to see the greatest impact although some volatility might emerge over the following months; that is, with the TLTRO still months ahead and the uncertain outcome of the ECB Asset Quality Review (AQR) likely to affect the growth of credit in the weaker euro area economies until October (when the results should be released), the investors’ confidence could be tasted this summer. Indeed, yesterday’s short-lived depreciation of the Euro serves to highlight this risk.
 
Today the sentiment is also likely to benefit from the easing in lending announced by China Banking Regulatory Commission. Defining World Bank’s and IMF’s call for structural changes that came out this week, the authorities are reportedly looking to support lending to small enterprises, infrastructure projects and home buyers. 

Whereas there is probably a consensus in the risks associated with continued credit growth in China, the markets at this stage are probably complacent enough to take comfort in the delayed slowdown

Finally, yet another boost came from Japan’s Prime Minister who asked the Finance Minister to bring forward the country’s giant pension fund  plan of increasing its allocation to equities. Today, the statistics material for markets will be German industrial production and trade data and the labour data from the U.S.
 
This article was issued by Calamatta Cuschieri, visit www.cc.com.mt for more information.

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