By Avantika Chilkoti
A month ago, investors were betting the European Central Bank would make a splash. Now they're not so sure.
Economists broadly expect the ECB on Thursday to reduce its key deposit rate by at least 10 basis points, or a 10th of a percentage point, from the current level of minus 0.4%. But expectations for the size of the monthly bond-purchase program that might also be announced have been eroding, a move that has helped keep once free-falling bond yields in place this month.
The recent volatility reflects shifting views on the appetite for a sizable stimulus package among ECB officials, as President Mario Draghi prepares to hand off the reins on Nov. 1 -- and, according to some portfolio managers, an overdue reckoning with the market's earlier wishful thinking.
"The market is very overexcited" about both the magnitude of the stimulus measures and the likelihood they will be effective in boosting economic activity across the eurozone, said Colin Harte, head of research in the multistrategy team at BNP Paribas Asset Management. Like many investors around the globe, he believes sluggish Western economies are unlikely to recover their former vigor without an aggressive government-spending plan that could over time significantly boost employment, wages and demand for goods and services.
"We doubt how effective monetary policy is, without fiscal expansion," he said.
The yield on 10-year German government bonds, which had dropped to as low as a record minus 0.742% on Sept. 3, recovered to minus 0.538% on Wednesday. That is still significantly lower than the yield of minus 0.405% on July 25, when the monetary authority said it was "determined to act" to bolster inflation. Yields fall when bond prices rise.
In anticipation of the stimulus package including the asset purchase plan, commonly known as quantitative easing, European companies are already selling bonds. In the two weeks from Aug. 26, about $33.58 billion of investment-grade debt was issued by companies in the region, according to Dealogic data, up from $9.63 billion in the previous two-week period.
But in recent days, some investors have started questioning if Mr. Draghi will hold off this week on offering specific details about the quantitative-easing program, while others have speculated that the ECB could surprise the market by opting to include bank credit, equities and exchange-traded funds in that plan. There is also an expectation that the ECB is likely to take steps to make negative rates less painful for banks.
As hopes of the fresh asset-purchase program mounted, investors piled into Italian and Spanish government bonds, which offer positive yields. The yield on 10-year Italian debt dropped to 0.801% on Sept. 4, from 1.526% when the monetary authority last met, while the yield on equivalent Spanish debt fell to 0.031% on Aug. 16 from 0.365%. Still, both yields have rallied slightly in recent days as the market pared back its expectations.
The market is also closely watching for stronger links between the forward guidance and inflation. The ECB's decisions could have significant implications for the eurozone's troubled economy, which has been racked by uncertainty over Brexit, global trade tensions and China's slowdown, a likely recession in Germany and political turbulence in Italy.
Meanwhile, analysts at BNP Paribas Asset Management continue to expect the ECB to deliver a 15 basis point-cut to the benchmark rate and purchase EUR300-400 billion of bonds over a year. That forecast was considered too low a few weeks ago, Mr. Harte said, but now appears to be in line with the market's consensus.
He has pared back his own position on European bonds and equities to slightly underweight in recent weeks, from overweight, on the expectation that markets might be headed for a disappointment.
David Zahn, head of European fixed income at Franklin Templeton, fears the ECB's decision-making committee will struggle to agree on a package of stimulus measures -- and the need for a new bond-buying program, in particular -- as they gear up for Mr. Draghi's likely successor, Christine Lagarde, to take over.
Ms. Lagarde, whose appointment is pending formal approval from European Union leaders, has pledged to review the costs and benefits of controversial ECB policy tools such as negative interest rates and large-scale bond purchases.
"They might be more open to expressing disagreement," Mr. Zahn said. He plans to buy up long-dated bonds and Germany government debt, in particular, if the market sells off on Thursday.
There is also concern that further rate cuts and quantitative easing might do little to boost growth and inflation, according to Moritz Sterzinger, a director at financial-advisory firm JCRA. Monetary easing amounts to "pushing on a string," he says, but disappointment on Thursday could roil markets.
"If the message is not quite as dovish as the market makes it out to be, I would expect there to be quite a big countermove again," he said.
Paul J. Davies in London contributed to this article
Write to Avantika Chilkoti at Avantika.Chilkoti@wsj.com
(END) Dow Jones Newswires
September 11, 2019 05:50 ET (09:50 GMT)
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