Markets Weigh Up Draghi Versus Trump -- Update
June 18 2019 - 2:59PM
Dow Jones News
By Paul J. Davies
European monetary policy erupted into a war of words on Tuesday.
For now, markets seem to be listening most closely to European
Central Bank chief Mario Draghi.
Mr. Draghi's suggestion in a speech of a fresh round of stimulus
sent key European government-bond yields to record lows and caused
the euro to fall against the dollar.
That drew the ire of President Trump, who tweeted that Mr.
Draghi's comments had weakened the euro in a move that was
"unfair," making it easier for Europe to compete against the
U.S.
German 10-year bond yields dropped to minus 0.321%, while French
rates touched zero for the first time ever, sliding from 0.11%. The
euro also slipped against the dollar, falling 0.2% to $1.1196.
In a sign of how investors are anticipating monetary policy
getting much looser, German government bonds with maturities
ranging from three months to nine years now have yields lower than
the ECB's main deposit rate of minus 0.4%.
The central bank has a number of weapons in its arsenal to take
action if inflation doesn't pick up, according to Draghi. "This
applies to all instruments," he said at a forum on the outskirts of
Lisbon. "Further cuts in policy interest rates and mitigating
measures to contain any side effects remain part of our tool."
Markets are now pricing in a rate cut of 0.10 percentage point
by September for the eurozone, according to investors and
strategists, effectively bringing forward expectations from some
point over the next year. Mr. Draghi may have been prompted to make
the comments by concerns that the U.S. Federal Reserve may pare
rates at its meeting on Wednesday. Lower relative U.S. rates can
cause the dollar to weaken.
Mr. Draghi responded to President Trump's criticism in a later
session of the forum, saying that the ECB didn't target the level
of the euro with its policies, only inflation. "We have our remit,
we have our mandate," Mr. Draghi said. "We are ready to use all
instruments that are necessary to fulfill the mandate."
"For Draghi, it is all about maintaining optionality and showing
that the ECB is still an effective central bank with tools at its
disposal," said Andrew Mulliner, a portfolio manager for global
bonds at Janus Henderson. "If the Fed cuts rates in July, or soon
after, and the euro rises to $1.15 or so, then it is very likely
the ECB will have to cut rates."
Europe has seen inflation expectations plunge in recent weeks,
which is another spur for Mr. Draghi to act. The "five year, five
year," an interest-rate derivative that measures inflation
expectations, has dropped in Germany to 1.23% from 1.39% in late
May. U.S. inflation expectations have also fallen to 1.97% from
2.32% in late May.
"From Draghi's perspective, the main risk is a stronger euro
weighing on inflation expectations," said Themos Fiotakis, head of
FX and rates strategy at UBS. "So whatever the Fed outcome
tomorrow, the ECB does need to fend off the notion that there is a
lot more space to ease in other economies."
A move to more deeply negative rates would be hugely unpopular
with Europe's savers and its banks, which have to pay to post
reserves at the ECB. However, the ECB is expected to introduce some
pain-relieving measures for banks, such as charging them lower
negative rates on some of their reserves, which was why Mr. Draghi
referred to "mitigating measures to contain side effects" of rate
cuts.
That helps explain why shares of banks in Europe rose even as
bond yields tumbled. Deutsche Bank rose 3.6% and a string of
smaller Italian and Portuguese banks also benefited.
Riskier credit looks set to benefit most from the softer stance
from the ECB, according to Mark Benbow, a fund manager at Kames
Capital, who said the most liquid index reflecting investor
interest in junk debt, the IHS Markit iTraxx Crossover Index,
rallied on the comments. "Both Draghi's comments on the limits of
QE and the potential for further rate cuts proved particularly
beneficial for high-yield bonds," he said.
"The ECB choosing to respond to economic weakness created by the
Trump administration's trade policy cannot sensibly be described as
weakening its currencies to gain an economic advantage," Seema
Shah, senior global investment strategist at Principal Global
Investors, wrote in a note.
Write to Paul J. Davies at paul.davies@wsj.com
(END) Dow Jones Newswires
June 18, 2019 14:44 ET (18:44 GMT)
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