ECB's Dovish Stimulus Cut Keeps Euro Under Pressure, Spurs Bonds

(Bloomberg) -- Traders piled into European government bonds and sent the euro lower after the European Central Bank decided to reduce its stimulus starting next year, but cushioned the effect by continuing to reinvest proceeds from maturing securities.

German notes may be one of the biggest beneficiaries, while those in Italy and Spain stand to gain as political risks in Europe’s periphery have faded over the past week.

The euro snapped a two-day rally following the announcement to cut the central bank’s bond-buying program to 30 billion euros ($35 billion) per month for nine months beginning in January, matching economists’ expectations. That’s down from 60 billion euros per month currently. Money markets now see the chance of a first 15-basis point ECB rate increase further into the second quarter of 2019.

ECB's Dovish Stimulus Cut Keeps Euro Under Pressure, Spurs Bonds

“The ECB is right, in that reinvestments should be sizable and we think in particular in bunds,” said Christoph Rieger, head of fixed rate strategy at Commerzbank AG. According to the bank’s own calculations, 30 billion euros will be reinvested in German debt alone over the course of 2018, with yields falling to 0.4 percent by the end of this year. “The scarcity premium will stay intact,” he said.

The euro traded 0.8 percent lower at $1.1721 as of 3:07 p.m. in London. German 10-year bond yields fell three basis points to 0.447 percent, while comparable securities in Spain led the rally with yields dropping 10 basis points to 1.53 percent.

Peripheral Bonds

For Arne Lohmann Rasmussen, a strategist at Danske Bank A/S in Cophenhagen, the decision from the ECB should keep peripheral government securities well supported. Spanish bonds were spurred by news Catalan President Carles Puigdemont may call elections this week, given recent polls have suggested the Catalan secession block could lose its majority in such a vote.

“You have continued support from ECB, the economy is improving and the latest political developments in Spain might even get the positive rating cycle back on track,” he said. On the whole, “they did not surprise hawkishly in any way.”

The ECB’s taper decision bodes well for Italian notes as well. An election law passed in the Italian senate on Thursday is expected to hamper the chances of the anti-establishment Five Star Movement getting into government.

Here are some analysts’ views on the ECB’s taper plan:

Rabobank (Matthew Cairns)

  • “There was little surprise, a move well orchestrated by the GC over the past couple of months,” strategist Cairns said
  • This achieves the dual goals of maintaining support and continuing to support the fledgling recovery across the euro zone whilst ensuring the market is not caught off-guard which runs the risk of destabilizing growth and unwinding the gains the ECB believes QE has made
  • Cairns expects bonds “will re-settle toward the levels prior to the decision”

Commerzbank (Thu Lan Nguyen)

  • The euro fell as the ECB decision disappointed hawks, says Commerzbank currency strategist Nguyen
  • “In the last two days, some people speculated that maybe the ECB could surprise on the hawkish side after all,” Nguyen says
  • “This expectation was disappointed, which is why the euro is weakening”
  • The move may only prove a “short-term reaction”
    • Forecasts EUR/USD at 1.20 by end of the year

Credit Agricole SA (Valentin Marinov)

  • “The reduced pace of purchases should push EGB long-term yields higher as the ECB gives the markets some breathing space,” says Marinov, head of Group-of-10 currency research at its corporate and investment-banking unit in London
  • “Steeper EGB curves could bode well for the euro as Eurozone investors find it less attractive to buy assets abroad”

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