Fra BNP Paribas:
But June should herald big changes from a number of sources:
• Monetary policy: It’s happening. Our economists expect the June ECB meeting to herald the beginning of the move towards tapering QE, with President Mario Draghi expected to change the characterisation of the economic outlook to “balanced”. The June FOMC should produce a rate hike and more concrete balance-sheet reduction plans.
• Prices: After two months of soft inflation numbers and falling inflation forwards, the euro area flash for May was just about strong enough to keep the reflation narrative alive: the US May CPI print will also be vital.
• Politics: The most likely outcome of the UK election is that uncertainty as to the UK government’s fiscal stance will fall, not rise. Likewise, James Comey’s testimony before the Senate intelligence committee may bring fireworks, but is unlikely to precipitate formal proceedings. Our expectation is that by the end of June the newsflow around the first two of these issues will indicate a bearish trajectory for yields in H2, albeit mitigated by political event risk on both sides of the Atlantic.
Furthermore, the effect of the year-on-year shift in the global balance between issuance and QE (lower chart) has not yet been fully felt so far this year – as is evident in the discussion on the next page of the balance between European sovereign issuance and ECB buying. We expect this too to put upward pressure on yields during the second half of the year.
Eurozone: Important ECB meeting ahead
Eurozone inflation remains low. At 1.4% y/y for the headline rate and 0.9% for core, eurozone inflation declined slightly in May. A decline in inflation breakevens has been the main reason why nominal yields have not risen in the last couple of weeks.
It is not unusual to see inflation breakevens decline in May, whatever the evolution of the CPI. Our economists expect upward pressures on inflation to resume in coming months (EZ inflation: Core inflation down but slightly above trend). Inflation breakevens should also rise. In the near term, German bonds often prove heavy in the first half of June. Even though political uncertainties in Europe could cap selling pressures on core European government bonds near term, we recommend a short outright exposure to the market in the coming weeks.
Next week, the ECB will unveil its new economic projections, which will be key for its forward policy guidance. A significant change in the forward guidance –opening the door to a change in monetary policy in coming months – is unlikely in our view. However, we expect the ECB to signal that while an accommodative monetary policy is still required in coming months, the economic backdrop is strengthening, leaving scope for a change in the ECB’s rhetoric before the end of the year, and a change in policy in 2018.
Our economists expect the ECB to phase out QE in the first half of next year and then hike its deposit facility rate by 40bp by the end of 2018. The money market curve has yet to reflect such a scenario. The eonia is priced at -0.23% by the end of next year, which implies a depo rate at -0.27/-0.29% – more than 25bp below our expected level. The lack or rebound in rates is also flagged in the 1y1y, currently at -0.25%. We expect it to rise sharply in coming weeks, closer to zero
