UBS: ECB looks to the banks for growth

But the most notable change for us was the introduction of a second round of targeted long-term refinancing operations (TLTROs) for banks – which gives them access to cheap funding to make loans. The ECB’s decision could offset some of the potential drag on banks from negative interest rates. We will be watching to see whether other central banks deploying negative rates, such as the Swiss National Bank, implement similar policies to boost bank lending. Markets have reacted negatively to suggestions from Draghi that rates may not move much lower from here. But within equity markets we believe that the ECB package is supportive of our tactical overweight position in Eurozone equities versus emerging markets. We retain overweight positions in US and European high yieldcredit.

What happened?

The ECB deployed a broad range of tools, which Draghi said would “complement each other” in encouraging lending and economic growth. Among them:

- The deposit rate was cut by 10 basis points to –40bps.

- QE was increased by EUR 20bn a month (to 80bn a month).

- The central bank announced four new TLTROs (“TLTRO II”), to be launched in June 2016 and to last four years, at borrowing costs potentially as low as the deposit rate.

What does this mean for investors?

Equities: While equities initially fell, looser monetary policy should increase the relative appeal of Eurozone equities. QE and lower rates should support profits, and we expect 3–7% earnings growth in 2016. This compares favorably with other markets, such as emerging markets (where we expect 0–5% growth).

Banks: Amid concerns that negative rates could hurt bank profits, several of the measures announced today could support the sector. The ECB's purchases of a wider range of bonds should help lower funding costs, boost credit quality, and support margins. And TLTRO II gives banks an additional incentive to step up lending. Overall, we expect a recovery in banking equities in the coming weeks supported by compelling valuations. That said, negative interest rates will remain a drag on sector profitability over the medium term, and could raise systemic risks, as banks could be encouraged to make riskier loans.

Fixed income: The expansion of QE should support credit, and we are overweight Eurozone and US high yield credit in our global TAA. In Europe, default rates remain close to zero and greater liquidity should support the segment. We will remain watchful of the impact of negative interest rates on bank profitability, given that banks comprise around 20% of the index. 

The euro: Although the euro is now trading higher than before the announcement, we expect it to depreciate against the US dollar in the near term. The ECB is loosening policy at a time when US economic data has been strengthening, and we believe the market may be too complacent in pricing in only one further rate increase from the US Federal Reserve this year. 

Author: Mark Haefele, UBS Global Chief Investment Officer Wealth Management

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