Richard Bailey
This week’s ECB Decision promises a change after the suggestion by Christine Lagarde at the October 29th meeting that, “the Governing Council will recalibrate its instruments, as appropriate, to respond to the unfolding situation”. Which she then went on to clarify further in the first question, stating:
“committees, staff members are already at work in order to do this recalibration exercise, and this recalibration exercise will touch on all our instruments. It is not going to be one or the other. It is not going to be looking at one single instrument. It will be looking at all our instruments”
The question this week, then, is not what can they do? but how much will they change and does the market think it is enough
Trading Lessons From History
The wide range of options available to the ECB makes this decision similar to the decision of June 2020 where again the question was not if, but how much action would be taken? It also follows a common ECB template of setting up action and then taking action at the next meeting a la July 2019 set up and September 2019 following the the July. So what Trading Lessons can we take from these decisions?
ECB Trading Lessons: September 2019
Priortise expectations are and absorb the information: The September 2019 ECB decision was a great example of this – expectations were broad and varied – including Asset Purchase Program (APP) €30b/month for 12 months, rate cuts of 15bps, introduction of tiering, possible adjustment of issuer limits from 33%-50% and change of guide on rates/APP. The most important thing here being size and duration of APP, which on the initial reading the ECB disappointed on with €20bn/month causing a dip in bonds (BTP and Bund) however when read fully there was no end date making this a much larger APP and therefore a buy for bonds causing a very strong reversal following a volatility halt in Bund which caught traders selling on the ‘lower’ €20bn/month
ECB Trading Lessons: June 2020 and October 2020
Which markets will react best: In June this year multiple options were available to the ECB, the focus of which was the Pandemic Emergency Purchase Program being increased by €500bn and extended to June 2021, second to that was whether the ECB could deviate from its capital key. It did both and increased PEPP by €600bn producing a a strong reaction in Stoxx, BTP and Euro but a more muted reaction in Bund which would not benefit so much from a capital key change.
A similar strong reaction was seen to the October 2020 “recalibration” commitment when it was enforced during the first question after the statement causing a rally in both Stoxx and Bund – the main lesson to be taken from both these decisions is that equity markets have reacted well recently to any increase in stimulus so perhaps give the greater conviction trade particularly as now both Stoxx and Dax have February highs in their sights
Trading Opportunities For December ECB
The key to the December meeting is distinguishing between consensus expectations and what some are looking for – potential change. First up the consensus:
- Increase PEPP €500bn to €1850bn and extend duration to End 2021 from June 2021
- Discounted rate on TLTRO extended to or past End 2021
The significant change that can come here is to the size of the PEPP increase, duration doesn’t matter so much because PEPP is a total number so the duration only alters the amount bought per month, rather than imply a larger amount of purchases as in APP. A more subtle change would be dropping the reference to using the the entire PEPP envelope which could be seen as hawkish as its full power will not be deployed. As learnt above equities could be the focal point for PEPP change. Other potential changes include:
- Increasing Tiering which had been a possibilty in July, and September – this would be beneficial banks and therefore equity markets
- APP increase from €20bn to €40bn per month – this could be the biggest surprise but its impact will be in respect to whether PEPP is increased or not:
- Increased PEPP and APP will be a big boost in stimulus and likely boost equities and BTP
- No change in PEPP and increased APP could be another example of September 2019 where the initial move on PEPP could be taken back as the rest of the information is absorbed
- Adjustments to TLTROs have historically been limited in their impact on the day along with the other potential changes to re-investments being extended and rules for Fallen Angels (countries who’s credit rating makes them ineligible for bond purchases) all of which will be peripheral to the main question around how much stimulus will be adjusted by.
Use the trading lessons learnt from previous decisions – make sure you have a clear plan as to what you will be trading, priortise the importance of the information coming out and absorb all information when there are multiple moving parts. For more on how to prepare and trade Central Bank Decisions check out the first Central Bank Trading Course in the World
Richard
