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ECB no longer credible? BTPs and spreads snub Lagarde

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ECB no longer credible?  BTPs and spreads snub Lagarde

Don’t panic on BTPs, no flame spreads ECB rate announcement post and Lagarde words. What happens?

Because the markets have not turned against the Italian debt, given that not only the Eurotower has turned a deaf ear, but he raised rates by 50 basis points, basically promising then to do the same thing in March?

The question is more than legitimate, if we consider that Lagarde’s ECB also appeared to be the most hawkish compared to the other central banks that dominated the scene yesterday and the day before yesterday: the Bank of England and the Federal Reserve.

Another reason why the question is spontaneous is the fact that, if you take a few steps back in time, that terrible BCE-Day of 15 December 2022 immediately comes to mind, when Lagarde’s determination to defeat the leap in inflation in the Eurozone it knocked out the BTPs, causing rates to fly above the level of those of the Greek bonds and making the BTP-Bund spread skyrocket, up to over 200.

ECB: Lagarde hawkish, but don’t panic BTP-spread

But yesterday none of this: the nightmare of BTP rates and spreads has not come back.

There are several reasons and they have been provided in the last few hours by economists and opinion leaders.

But in these hours everything is about to be questioned again. Who is it that is taking or is risking making a blunder: central banks or markets?

Practically, who has a distorted perception of reality, central banks or markets?

A few minutes ago it arrived the positive shock of the US employment report.

Probably even Jerome Powell’s Fed could never have imagined the creation of new jobs, in the month of January, of 517,000 units. And the drop in the unemployment rate to 3.4%.

Far from a recession: the economy made in the USA seems to be marching at a decidedly faster pace than feared.

On the other hand, a few days ago it was the same IMF-International Monetary Fund to have to admit that the resilience of the economy (and we are talking about the global one) is surprising.


ECB and rates, other than appeals Italy. Lagarde goes straight

Returning to the questions of Europe, more precisely of Italy, the BTP-Bund spread and the BTPs themselves they’re giving an equally astonishing showdown.

The words uttered yesterday by the president of the ECB Christine Lagarde not only did not depress the Italian paper, but they also triggered a rally (which concerned the fixed income market in general, made in the USA included).

Andrea Lisi of Equita SIM explained the positive reaction of the markets, pointing out that, during the press conference following the announcement on ECB rates, “President Lagarde has indicated that she intends to hike by 50bps at the next meeting it does not represent an absolute and irrevocable commitment. A factor, this, that would have left “space for possible interpretations of a slowdown in monetary tightening”.

Not only.

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Speaking of BTPs and the much feared QT-Quantitative Tightening, Lisi recalled that “The Governing Council has defined the modality of reduction of the titles in the framework of the APP (reduction of 15bn per month from the beginning of March to the end of June, which will be followed by a subsequent remodulation over time)”, indicating that “partial reinvestments will continue to be conducted in line with current practice.”

Not for nothing, reports Andrea Lisi, “after the monetary policy decisions, EUR 3M forward curve moved down, projecting for 2023 an average rate level of 3.2% (about -20bps compared to the previous day)”.

The markets are betting on an about-face by the ECB

It was also to give his interpretation to the words of Christine Lagarde Jamie Niven, Senior Fund Manager at Candriam:

It is evident that the market was positioned for a hawkish ECB”.

Said this, despite explicitly hawkish statements from the central bankwith a return to forward guidance (despite having been thought to have been abandoned) and ‘intention’ to make another 50bp hike in March, we have seen a strong rally in bonds”. Including, precisely, the BTPs.

The reason?

“I think there is a good chance of a monetary policy error by the ECB. While inflation is still well above target and growth data is unequivocally more positive than two months ago, with gas price developments and China‘s reopening bringing tailwinds, the cycle of higher rates has been aggressive in Europe, even more aggressive than the Fed in terms of the pace of rate hikes, despite a later start date. The fear is that the delay in the transmission of monetary policy will cause a weakening of growth in the second half of 2023. The reaction of bond prices after the ECB announcement suggests that the market tends to be on board and doesn’t really believe the ECB can maintain this hawkish tone for longer than already anticipated.

According to Candriam, the increases would have started simply because, despite all the efforts made by the president of the ECB in trying to convince the whole world of the fact that it does not want to retreat in the face of inflation, the market no longer believes its words.

As well as markets wouldn’t even believe Jerome Powell’s Fed anymore.

Markets to Central Banks: We Don’t Believe You

To talk about this divorce between central banks and markets is a Reuters article, the title of which says it all:

“Markets to central bankers: we don’t believe you”.

Translated: “Markets to Central Banks: We Don’t Believe You”.

Evidence of this distrust is not lacking and are all engraved in the trend of the markets, as stated in the Reuters analysis.

“On Wednesday, the Federal Reserve raised fed funds rates by 25 basis points to a record high since 2007, continuing its battle against inflation. Despite this, the S&P 500 index tested the high of the last five months, with traders firmly believing that the most influential central bank in the world will change course soon.” And “the government bond markets (US Treasuries) continued to price the prospect of rate cuts by the end of the year, with the turn of the economic cycle”.

In a certain sense, it can be said that the assist in this dovish bet came against his will from the same Jerome Powellchairman of the Federal Reserve, who even spoke of disinflation.

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After the Fed and before the ECB, the turn of the Bank of England has come raised UK rates by 50 basis points to 4%the highest value in the last 14 years.

However, the BoE also wrote in the press release that “Inflation as measured by the consumer price index globally remains elevated, although it is likely to have tested peak in many advanced economies, including the UK”.

The UK central bank added that “Wholesale gas prices have fallen recently as disruptions affecting supply chains have somewhat subsided due to global demand”.

Highlighting the discrepancy between markets and central banks:

“Many central banks have continued to raise rates, although the market prices a rate cut going forward”.

In the end, last but not least, Christine Lagarde’s ECB has arrived.

Reuters scrive:

“In Europe, the European Central Bank announced a 50 basis point rate hike, promising to do the same thing in March and beyond. Euro area markets also rallied. The Stoxx 600 index has been testing the record high since last April, German Bund rates fell 23 basis points, posting the sharpest drop in almost a year, as their prices jumped. BTP rates marked the steepest drop in a day since the ECB launched its emergency measures during the Covid-19 crisis in 2020.

Explaining the market reaction was Salman Ahmed, head of the global macro and strategic asset allocation division at Fidelity International.

Ahmed told Reuters news agency:

“The markets are saying ‘You can say what you want now, but we know you’ll change your mind.”

The US Treasuries also spoke loudly after the Fed, continuing a trend that began in 2023.

Just think that 10-year YTD yields plummeted by 50 basis points around 3.3%, after surging 236 basis points over the course of 2022.

Today the rates of 10-year BTPs are shooting again, jumping by 10.5 basis points to 3.99% according to Reuters surveys.

But yesterday the same rates fell 40.5 basis points, reporting the most significant thud since March 2020, the year to which the beginning of the Covid-19 pandemic is traced.

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The market is looking for any signs of a slowdown in inflation and the end of the rate hike cycle.” commented Jan von Gerich, Chief Analyst at Nordea, who added:

“I don’t think the reaction we witnessed yesterday was in line with what the ECB intended to communicate, but at the moment the market is pricing in this, and it could continue like this in the short term. Sure, there could be some disappointment ahead, in that central banks could be more hawkish than the markets are betting on right now”.

A ‘rate cut’ reaction

Watch out for the comment too Gareth Jandrell, del team Public Fixed Income di M&G Investments:

“As expected, the ECB made another 50bps hike. Furthermore, Lagarde revealed plans to make a similar hike in March. The Governing Council remained firm in its statement of raising rates ‘significantly’, ‘at a steady pace’ and ‘while keeping interest rates at restrictive levels’. One might therefore think that the ECB is still there on a hawkish trajectory. Markets felt differently, reacting as if the ECB had just announced a rate cut, with a strong rally in eurozone bonds and a weakening euro.

Jandrell explained the reaction thus:

It is clear that the market is desperate for a sign that the ECB will soon begin to slow the pace of tightening, so part of the dovish reaction could be due to positioning. Even President Lagarde, who described the risks of inflation and growth as more balanced, will have given confidence to bond investors. Nonetheless, this rally it seems premature: headline inflation remains far off target, core inflation has not yet seen a significant reduction and, as we have seen recently in Spain, core inflation can still surprise to the upside”.

As regards the anti-BTP and anti-euro area government bonds maneuver, i.e. the Quantitative Tightening, the M&G Investments expert commented as follows:

There’s not much more to add on European QT compared to what was already heard at the December meeting, except that reinvestments will be largely proportional between APP portfolios and that reinvestments of the ECB’s corporate bond portfolio (CSPP) will be oriented towards issuers with better climate credentials”.

The point is that “it is not yet clear how these credentials will be defined, as they will be determined by a mix of measures ranging from absolute emissions to good reporting practices”. So, “I suspect investors will focus about which bonds are bought and sold by the ECB each week to figure out who’s on the naughty list.”

But in yesterday’s session, immediately after the ECB’s announcement, BTPs and spreads have turned a deaf ear on this issue as well.

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