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ECB Policy Summary: March 2019

Core Content

The European Central Bank (ECB) held a policy meeting in March 2019, where it made a notable decision to extend the period of ample liquidity from March 2021 to March 2023. This move, combined with downward revisions to growth and inflation forecasts, was interpreted by the market as a dovish signal. However, the underlying details of the ECB's policy action revealed a more mixed and cautious stance.

The ECB's growth projections for 2019 were revised significantly downward from 1.7% to 1.1%, while inflation forecasts for 2021 were also adjusted, coming in at 1.6% instead of 2%. These revisions suggest a more pessimistic outlook than previously communicated, yet the ECB still expressed confidence that recession and deflation risks are low. This optimism appears to contrast with the "downside tilted" risk assessment and the metaphor of being in a "dark room" used by Mario Draghi to describe the ECB's position.

The ECB also announced changes to its forward guidance, shifting the date element to year-end, which was seen as a way to avoid committing to a long-term rate path. This move is viewed as a compromise, possibly due to internal divisions on policy normalization and the desire to avoid tying the next ECB president's hands.

Main Views and Key Information

Market Reaction

• The EUR weakened following the ECB meeting.
• EURUSD approached key support at 1.12, with a potential break below this level indicating further downside.
• The market interpreted the ECB's actions as a signal of "low for longer," favoring carry trades and forward steepeners.

Carry Trade Recommendations

• Long 5y Spain (SPGB): Entry at 0.21%, current at 0.10%, target at 0%, stop at 0.28%.
• Long 5y France (FRTR): Entry at -0.04%, current at -0.16%, target at -0.25%, stop at 0.03%.
• BTP 3s5s Flatteners: Entry at 117bp, current at 114.5bp, target at 100bp, stop at 127bp.
• Bund ASW Compression: Entry at 57.4bp, current at 52.4bp, target at 48bp, stop at 61bp.
• 2y2y vs 10y10y EUR Swap Steepener: Entry at 156.5bp, current at 160bp, target at 165bp/175bp, stop at 150bp.
• 2y Forward EUR10s30s Steepener with Long 5y30y Payer Swaption: Entry at 25bp, current at 37bp, target at 40bp, stop at 15bp.
• Receive 5y EUR Swap vs Long 1.2% USD 5y Inflation as a Hedge: Entry at 122bp, current at 161bp, target at 180bp, stop at 140bp.
• 3y Forward 2s30s Conditional Bear Steepener with Payer Swaptions: Entry at zero cost, current at +6bp, target at +10bp, stop at -5bp.
• Long 1x2 Receiver Spread (ATM vs ATMF - 25bp): Entry at 6.6bp, current at 8.3bp, target at 10.6bp, stop at 4.6bp.

Profit Booking

• Short OAT Invoice Spread: P&L of +2bp.
• Long 10y Bono vs OAT: P&L of +11.5bp.

FX Strategy

• EURJPY Short Trades: Preferred as a better expression of the bearish macro view on the eurozone.
• EURJPY 125 Digital Put (1 Aug 2019 expiry): Continues to be held in the trade ideas portfolio.

Potential Risks and Hesitations

• The ECB's policy action and growth projections were seen as overly optimistic.
• The lack of clarity on future actions, especially in the event of downside risks, suggests hesitation and a lack of commitment.
• The ECB's forward guidance may not be sufficient to prevent a more sustained economic slowdown.
• The TLTRO-IIIs were announced with a floating rate, which is less dovish than expected, potentially limiting the effectiveness of the policy.

Strategic Implications

• The ECB's decision may indicate a reluctance to commit to a prolonged period of low rates.
• The choice of the next ECB president is seen as critical, with the current stance possibly leaving the Council in a position where further action is difficult.
• The ECB's approach may risk falling behind the curve if economic conditions deteriorate further.

Conclusion

The ECB's March 2019 meeting sent a mixed message, with a dovish tone but limited policy commitment. The extension of ample liquidity and the downward revisions to growth and inflation forecasts were interpreted as a "low for longer" stance, favoring carry trades and flattening the yield curve in certain markets. However, the lack of clarity and the potential for a more prolonged economic slowdown suggest that the ECB may not be as prepared as it appears. The document highlights the importance of monitoring the ECB's future actions and the risks associated with the current strategy.