Robeco: ECB - Why risk an early end to the recovery?

Tightening in tougher conditions

ln our new Central Bank Watcher,we examine the policy and actions of the world's major central banks (Federal Reserve,European Central Bank,People's bank of China and the Bank of Japan). The Robeco GlobalMacro team Iooks at expectations for growth,inflation and the term premium,for example,and analyzes monetary policy and geopolitics to see how thesewill affect the macro outlook and financial markets going forward.

Accordtng to R tkkert Schalten,after the recent rally in bonds, there t s some room to pr tce in a more hawkt sh trajectory for both the Fed and the ECB, but thts remains ltmited. Yes, we expect continued  htkes by the Fed and a start of the ttghtening cycle by the ECB, but these expectati ons are largely prtced tn already. Do es this s ttuatton tmply that central banks have taken the art of guidance to the next Ievei, or will it mean that unexpected events- more volatile oil prices, aspikein inflatton, further deterioratton in ltaly have far more impacF

Close to perfection

Between now and the end of 2019, 70 bps in rate hikes are prtced tn for the Fed. This is still 30 bps below what is expressed in the Fed's most recent dot plot, but as markets tend to have difft culty tn prtcing in dots further out,we )Udge the current pricing to be about  as good as it can be. Only a higher dot plot would justify a further move upward in sho rt·term yt elds. 

But,wrth infl ation expected to remam close to target and thefirst signs of risky assets coming under pressure, we don't think there will be much appetite to push up the dots.

As for the ECB, the firstrate hike has already been endorsed by Draghi and has been priced in by the market. So probably no surprises here either. The deposltfacllity  rate is likely tobe increased  by 15 bps rn September or October 2019. We are less optimistic  on core rnflation than the ECB, with a forecast of 1.2% by the end of the year (compared to the ECB's forecast of 1.5%). Although  inflation expectations are generally stable, a volatile oil price, for example, could throw a spanner  in the works.  As could  the politrcal backdrop rn Europe, which is an area of focus for the region However, despite the imminent end of the ECB's band buyrng program, it strll has a card up rts sleeve in the form of rts reinvestment policy This can offer the centrar bank a tool to continue to help the markets out with liquidrty if things start to go sour

Term premium set to decompress

Wrth an upward traJectory  for short-term rates  already priced in and stable  rnflation expectations, we expec t the term premiumtobe the main factor drrving band yields in the comrng period. The US is further advanced in the trghtening cycle, is seeing a rapid rncrease in net issuance and has  a much  !arger free float of sovereign bo nds than Germany, for example. As a result, we expect  US Treasurres to be the most vulnerable market when it comes to rising term premrums and so we expect the US Treasury  curve to steepen. For Germany there  is less room for curve steepening at thrs pornt in time.

The Chmese curve has flattened  recently and the spread between Chinese government bonds and  US Treasuries  has tightened s rgnificantly. China is not unique in trading at a low yield relative to the US. Canada, Germany, Australr a a nd the U K are in the same camp. But many EM countrres would experience  wider spreads rf therr currency deprecrated as much  as the renmrnbr has, China, however, is drfferent. Thrs shows  that Chinese government  bonds are acting as a true safe haven We expect contrnued  divergence in economic  conditr ons between the US and China and see room for this spread to tighten further.

Other topics:

• ECB: Why risk an early end to the recovery?
  
• Fed: Enough priced in for now
  
• PBoC: Juggling different objectives
  
• BoJ: Time to change the 10-year JGB's target range?
  

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