Reading BAML comments on the ECB “Rorschach test” yesterday,
It is even more ironic that this reaction occurred as Draghi acknowledged there were limits to how low negative rates could go before the banking sector would be harmed. Market commentary around negative rates had itself become quite negative in recent weeks, growing ever more vocal since Japan implemented NIRP. Draghi and colleagues surely felt they were doing the right thing in pivoting away from relying on ever more negative interest rates, and we agree. Yet it appears that this move was an important catalyst in the market selloff from around 2 PM London (9 AM NY) time.
Indeed, the selloff only makes sense if markets were pricing in a large positive boost from negative rates in the Euro area. And that may be one way to reconcile the euro and interest rate responses, assuming that more negative rates were already priced into the currency and the longer end of the yield curve. However, if markets did, in fact, believe that negative rates were a bad idea, then they should have celebrated the ECB’s confirmation that it would not perpetuate that “policy mistake,” not sold off.
So once again there is a puzzling contradiction within the market’s reaction. This leads us to suspect that markets were simply “in the mood” to sell off after the ECB’s announcements, and it did not take much of a catalyst to do so. In our view, it’s hard to argue that the program itself was a disappointment. True, it didn’t have everything the consensus was expecting — for example, the purchase period was kept “at least through March 2017” rather than extended for another six months as widely anticipated. However, objectively the program delivered a more-than-offsetting set of dovish surprises — which the initial market reaction confirmed.