Halister News

(Bloomberg) -- There’s no sign yet the ECB’s latest salvo against disinflation will work, market prices show. European inflation derivatives have sunk to new lows after President Draghi last month unveiled measures from rate cuts to expanded asset purchases, Bloomberg strategist Tanvir Sandhu writes.

• Inflation forward curve shows ECB’s target of close to 2% isn’t expected to be met even in 20 years: 1y HICPxT forwards flatten from 10 years at ~1.7%, see chart here
• Forwards are weighed down by EUR gains, and require realized inflation to improve as de-anchoring of expectations amid large slack takes hold; EUR is ~2% stronger since March ECB meeting as investors took the statement as shift away from rate cuts, and as USD lost ground amid re-pricing of Fed hikes further out
  • Cost to protect against inflation exceeding ECB goal remains at or near record lows for all maturities; EUR 2% 10Y ZC cap premium has dropped to 89bp vs 208bp on Dec. 1, approaching Dec. 2014 record low of 78bp reached amid deflationary fears
  • See chart here on ZC cap, EUR TWI (inverted), Brent

DEFYING DRAGHI

• Price expectations are abating even after Draghi indicated a period of inflation overshooting may be necessary, after a protracted period of undershooting, to defend the ECB’s policy symmetry
  • ECB meeting on Thursday likely to re-iterate “comprehensive package” announced in March
• 5y5y inflation swap vs core HICP spread has narrowed, showing little embedded inflation risk premia
• Moreover, Eonia curve has re-priced following ECB March accounts and speeches by officials signaling that further rate cuts are still possible
  • Eonia now pricing in 74% probability of a 10bps ECB deposit-rate cut in Dec., compared with 52% immediately after the reserve-maintenance period lapsed
• Draghi will need to ease policy again this year, according to a Bloomberg survey of 47 economists conducted April 8-14

DIVERGING FROM OIL, CARRY

• Divergence between inflation forwards and front Brent contract persists ahead of ECB; see chart here
• Seasonal turn to positive carry may now attract tactical investors
  • Follows poor carry in March for EUR linkers accreting seasonally weak Jan. HICP print

• NOTE: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for First Word. The observations he makes are his own and are not intended as investment advice.