Fed and ECB: update to our views

Willingly or grudgingly, the Federal Reserve will have to assume its status as the “global” central bank and address uncertainties over dollar funding and high yield credit. To pave the way for fiscal measures to then take over, we expect: Two cuts of 50bp each in quick succession, in March and April, lowering the Fed Funds rate to the zero lower bound (ZLB). Nonconventional measures , featuring an increase in repo operations to begin with, then a commitment to make available swap lines or repo facilities to banks. In the event of massive outflows from money market funds, and immediately upon touching the ZLB, a new round of QE. Forced as it will be into taking emergency measures, the Federal Reserve will have to consider that possible measures might be needed in the event of a further deterioration in the outlook, in addition to which a deft steering of liquidity will be required. The European Central Bank (ECB) can be expected to announce a raft of measures when it meets this week. Our expectation is that it will announce: A 10bp cut in the deposit rate from -0.50% to -0.60% . An open-ended increase in monthly asset purchases under the APP from €20bn to €40bn from 1 April. An increase from 6 to 8 of the multiplier applied to calculate the amount of liquidity deposited at 0% by European banks, which would lead to a €270bn increase in 0% deposits. A more generous bonus for TLTRO III if there is an increase in the stock of eligible loans, notably an increase in loans to SMEs , and/or the adoption of a specific mechanism (such as a Funding for Lending Scheme). On this basis, ECB asset purchases would increase from €242bn in 2019 to €618bn in 2020 . In the specific case of the CSPP, purchases would increase from €17bn to €106bn this year, with purchases at their highest annual level since the programme was launched . In the absence of guarantees for loans extended to corporate customers and/or a modification of capital requirements, it is likely that banks will curb lending to the economy, notably so as to avoid a rise in the proportion of nonperforming loans . As regards Europe, our view is that interest rates will rebound in H2-20, lifting the € 2-year and 10-year swap rates to -0.29% and 0.08%, respectively, at the year-end. As for sovereign spreads, our bias remains for a tightening . We see the 10 year BTP-Bund spread narrowing as tight as 135bp by the end of June .