UBS: Inflated expectations
Managing expectations can be an exercise fraught with difficulty, as last week's announcement by the ECB demonstrated all too clearly. The market regarded the outcome of December's meeting as the most disappointing for years. Could it be that Mario Draghi, who has so successfully managed the market's expectations in the past, has become a victim of his own success?
08.12.2015 | 08:55 Uhr
When everyone is trying to get one step ahead of everyone else, expectations are crucial. Financial markets are all about buying an asset before everyone else buys it, or selling it before everyone else sells it: in other words, expectations. Central bankers know this as well as anyone else, so they try to manage expectations. But expectations can also be mismanaged.
The European Central Bank (ECB) seems to have done just that. Ever since the October ECB meeting the expectations of a significant further easing began to build. ECB President Mario Draghi started the management exercise by announcing that even though they had not done it, the ECB had considered cutting the deposit rate further into negative territory. This was quite a surprise given that the ECB had previously insisted the rate could not go lower. Expectations were then inflated further still by press leakages of additional quantitative easing (QE) backed up by more dovish comments from various ECB members. There was even speculation the ECB could buy high risk bank loans.
Given the ECB's track record of surprising to the dovish side, expectations of further easing measures rapidly got out of control. So when the announcement of a bit more easing came through, it ended up being a disappointment. In fact, the December ECB meeting was the most disappointing for years, at least compared to what the market wanted to see. The EUR posted a big rally against the USD when the statement turned out to be more hawkish than the price reflected (chart 1). Equities also posted their largest decline on an ECB announcement, and bund yields spiked up.
To be fair, at least compared to the October meeting (and ignoring all the speculation in between), the ECB was dovish. Not only did it cut the deposit rate by a further 10 basis points, but they also extended QE by a further six months (something not explicitly mentioned in October). But conspicuous by its absence was an increase in the monthly pace of QE. Rumours about a two-tiered deposit rate that would penalise banks for holding too many reserves also proved unfounded.
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