Much ado about nothing: the European Central Bank fails to boost the periphery

Bonds
Althea Spinozzi

Senior Fixed Income Strategist

Summary:  European sovereigns fell even though the ECB delivered more than expected. The market is failing to see that more stimulus is ahead as the central bank will need to continue to stimulate the economy to revive inflation. However, the good news is coming from the EU Summit as Hungary and Poland lift their veto on the EU recovery fund. Thus, more upside is ahead for periphery with Spanish 10-year yields poised to dive below zero within days and the spread between BTPs and the Bund to fall below 100bps in the first quarter of 2021.


This year's Santa Claus has a name: Christine Lagarde. What she's bringing to every European household is the hope for economic recovery and ever high bond prices.

There is no need to wait for the Christmas day to have the presents delivered. As a matter of facts, there wasn't even need to wait for the ECB meeting today to see European sovereigns moving up to unprecedented highs. The market has been pricing more stimulus from the central bank for more than a week. Portuguese 10-year yields dived below zero on Tuesday, and Spanish 10-year yields toyed with this level today as they touched 1bps before the ECB rate announcement. In the morning, European rates fell considerably without even blinking to the possibility that the ECB might disappoint.

Indeed Christine Lagarde did not disappoint and announced an extension of the Pandemic Purchase Program (PEPP) until March 2022 and boost it by €500 billion. The TLTROs programme also was extended until June 2022. These measures exceeded market expectations, but they failed to give an additional boost to European sovereigns.

Seeing European rates pointing higher after the ECB announcement was a complete surprise. The ECB bluntly said that it is willing to give unlimited support to the European economy until there is a stable recovery and the inflation target is not met. Besides, Hungary and Poland lifted their veto over the EU recovery fund, pointing to the fact that there will be no lack of stimulus next year.

To strengthen expectations of more stimulus coming in the next few years, the ECB forecasted inflation at 1.3% in 2023, which is well below the central bank's target. The ECB might not have come in in full force today because it is expecting that more stimulus might be needed in the next few years. After all, inflation is nowhere near its target.

These are bullish news for the credit space.

Investors should not be discouraged by low or negative yields in the Euro area because the graph below is showing that there is still more room for tightening. The option-adjusted spread of European sovereigns and credits is still wider compared to what it was before the Global Financial Crisis of 2008. It means that if the ECB wants to, it can do a lot more than what it is doing now. Hence, the periphery will resume rallying.

As explained in an earlier analysis, we are seeing the spread between 10-years BTP and the Bund falling below 100bps. At the same time, the spread between 30-year BTP and the Bund will most likely fall to 120 bps withing the first half of 2021. This means that longer dated Italian government bonds have an upside of 10% in capital appreciation.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
Beethovenstrasse 33
CH-8002
Zurich
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved, we have put together a general Risk Warning and a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed here or within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law.

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.