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We received the shortest ECB press conference in three years today and, to be honest, we have not learned a lot. We might be happy because the little we got tends to confirm our preview but we would have been happier if Mario Draghi had more clearly confirmed what we feel. Tapering fears are clearly overstated: albeit M. Draghi did not commit to anything, the ECB does not seem to be in the mood for a monetary policy tightening in the near term.
Because of an illegitimate, disturbing and – let us say it – highly contestable monetary-policy framework from the ECB, the economic, financial and political future of Portugal lies in DBRS's hands. On 21 October, DBRS will update its opinion on Portugal. If it downgrades the country's credit rating by one notch then Portuguese bonds will no longer be eligible as collateral at ECB refinancing operations nor for QE. Our base-case scenario is that DBRS will not downgrade Portugal and that it will keep its outlook unchanged (stable).
Yesterday, an article by Bloomberg hit the wires and triggered a strong reaction in the markets: according to Bloomberg, the ECB Governing Council is trying to build a consensus towards the fact that QE will have to be tapered. Of course, "the officials asked not to be identified" and, to be honest, the actual content of the article is way less catchy than the headline: it does not say at any point that the ECB's tapering is to be started in the near term. On the contrary, it explains that "they didn't exclude that the program could still be extended at the full pace of 80 billion euros ($90 billion) a month".
The FOMC, as widely expected, opted for unchanged policy at its September meeting with the Fed funds target range maintained at 0.25% to 0.50%. Market participants saw a relatively low probability for a rate hike with policymakers split over the near-term rate normalization path. We look for the FOMC to hike the Fed funds rate by 25 bps on 14- December. Chair Yellen's comment that the case for a rate hike has strengthened was echoed in the statement. Moreover, the FOMC noted that the "near-term risks to the economic outlook appear roughly balanced."
The ECB did not officially extend QE, but they clearly pointed towards a change in the modalities over the near-term ("tasked the relevant committee"); we see it as a step towards an official extension in October or in December this year, along with an easing of purchase modalities, probably a removal of the deposit rate floor.
Paradoxically, the six-month 'official' extension of QE is insignificant, despite amounting to EUR480bn: QE is already in open-ended mode and markets are already convinced that it will run beyond March 2017. As long as markets continue to expect the extension, the timing of its announcement matters little. President Mario Draghi will, we expect, point to the extension on Thursday to ensure this remains the case.
In spite of a renewed extension of the deadline to correct the deficit, full compliance with the Stability and Growth Pact is still at risk given the current political deadlock. Until a consensus about constitutional, geographical and fiscal reforms is reached, political uncertainty will linger and weigh on fiscal metrics. Sustained nominal growth and exceptionally favourable financing conditions should nonetheless allow the fiscal deficit to decrease gradually.
FOMC voters thought it was appropriate to wait for additional information in order to gauge the underlying momentum in the labor market and economic activity before taking another step in removing monetary accommodation. "Most participants anticipated that economic growth would move up to a rate somewhat above its longer-run trend during the second half of 2016 and that the labor market would strengthen further." We believe that Chair Yellen is willing to test the downside of the natural rate of unemployment in order to meet the Fed's maximum employment mandate.
We have analysed the scarcity issue for German bonds as it is the most obvious impediment to the smooth running of the purchase programme until a suitable end time. Our conclusion was not extremely reassuring as it pointed to difficulties for the ECB starting this winter.
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