Idea of the day: Deutsche Bank, looking to the ECB for support

The UK election isn’t the only event traders need to watch this week, the ECB meeting also takes place this Thursday and even subtle changes from the ECB could impact the markets.

What: the UK election isn’t the only event traders need to watch this week, the ECB meeting also takes place this Thursday and even subtle changes from the ECB could impact the markets. Our base case is that the ECB may decide to drop its bearish bias for the Eurozone economic outlook at this meeting and it may also adjust its forward guidance, for example by dropping a reference to the possibility of a further cut to the deposit rate facility.

A recent dovish tone to ECB President Draghi’s speeches suggests that the ECB will avoid announcing an early taper of its Asset Purchase Programme. However, although the changes that we expect are modest, we still think that they could have a knee-jerk reaction in financial markets.

What: We believe that the biggest impact from any change to the ECB’s forward guidance could be felt in the European bond market and European banking shares. The flattening of the German yield curve from June to March, where there was little difference between short term and long term bond yields, was disastrous for European banks as it made it difficult for them to make money from lending.

Figure 1 below shows the chart of the 2-year German bond yield – the 5-year German bond yield. This had been falling until March, since then it has started to steepen as the outlook for the European economy has brightened, however, it remains in negative territory at – 27 basis points. We believe that if the ECB drops its forward guidance on the potential for further cuts to the deposit rate then the German yield curve could continue to steepen, and potentially get back into positive territory. This would boost the earnings’ outlook for the European banking sector, and we would expect Deutsche Bank, Germany’s largest bank, to benefit.

The German yield curve and Deutsche Bank – a relationship restored?

Deutsche Bank’s share price had been in recovery mode since the basing in the German yield curve, however, it has pulled back since reaching a high in early May, and it is now at its lowest level since 20th April. We believe that a shift in the ECB’s forward guidance could trigger a recovery in DB’s share price, back to key resistance at EUR 17.50, approx. EUR 2 higher than where we are today. We think that DB’s share price will follow the direction of the German yield curve, so figure 1 is a chart to watch this week.

Figure 1: 

Source: City Index and Bloomberg

Figure 2: 

Source: City Index and Bloomberg

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