Goldman Sachs: A Double-Edged Backstop

Goldman Sachs note that “with downside growth risks building again, ECB communications last week did not leave much room for speeding up rate hikes, which was a near-term negative for EUR. The ECB’s more careful approach to policy normalization also carries some potential medium-term risks for the Euro. We have been surprised that the ECB appears ready to deploy a new backstop tool despite what looks to us like relatively limited evidence of Euro Area fragmentation - our rates strategists have argued that wider spreads are consistent with the macro outlook and the ECB stepping back from the market. On the one hand, the ECB’s commitment to smooth policy transmission is a positive for the currency as it diminishes sovereign credit risk. But this is not without costs. A key component of our medium-term bullish outlook is that a structural change in monetary policy will help attract private sector investors again, which would help reverse the EUR3tn in fixed income outflows since the start of the negative rate era. But if the ECB moves slowly over fears of creating stress in sovereign bond markets, risk-free rates may remain moderate for a longer period. We still think the ECB’s relatively cautious approach is more likely to delay rather than derail the Euro’s recovery, but it is worth keeping in mind that we do need monetary policy to step back a bit for our thesis to play out.”