The one thing that stood out in Thursday’s QE announcement by the European Central Bank was how they managed market expectations, said Bob Parker, senior Advisor at Credit Suisse Asset Management.
There was fear in the markets that the ECB would fail to meet expectations, but the central bank managed them very well. They came out with a program, which was well in excess of market expectations. That explains the drop in bond yields on Thursday and Friday.
Ten-year yields in Italy and Spain fell below 1.5 percent, and they are likely to stay there for some time in future. Also, the ECB may be very careful about what it says in public, but it must be very happy with the devaluation of the euro in private, given the fact the euro has come down to about $1.13 now from $1.39-$1.40 in last May-June, he added.
Asked if the composition of ECB’s €60billion/month asset-purchase program really matters, Bob answered in the negative. Although the ECB is yet to release the finer details of the asset purchase program – the proportion of government. and corporate bonds it intends to purchase, that’s less of a concern now.
The transmission mechanism through the real economy is what matters. Following Thursday’s announcement, institutional investors will see very low government bond yields for at-least for the next six months. In certain European markets yields have already fallen in the negative territory, in fact 20 percent of Europe is witnessing negative government bond yields.
That’s going to drive investors out of that bond market, and into the corporate bond and other riskier asset markets, which is exactly what the ECB wanted to achieve. Logically, that should provide a significant stimulus to the eurozone economy.
In addition, the euro-area economy is being boosted by a number of other stimuli at the moment including lower energy and commodity prices, which in-turn should boost consumption. The devaluation of the euro should have a significant effect on the region’s economy as well and the recent jump in German-exports proves that point, he noted.
Banks in Europe are selling their bonds to the European Central Bank, and then they get negative rates when they park the same cash with the ECB. Asked to comment, Bob said the one weakness in the eurozone economy is the banking system.
Over the last few years, the banking system has de-levered and has become very liquid, but demand for credit has failed to pick-up as well. While the ECB’s latest move will boost asset prices, questions still linger over a pick-up in bank credit. Latest data, however, show bank-credit now is finding a bottom and there has been a modest increase in credit off-take.
The next two-to-three months will remain critical in terms of bank lending data and an increase in bank-lending is likely in that period. But the transmission-mechanism between ECB’s QE and bank-lending vis-à-vis demand for credit remains fairly opaque, he observed.
The Danish central bank has cut rates unexpectedly following the ECB’s move. Asked if the Danes will defend their currency peg, especially when the Swiss have abandoned the franc’s peg, Bob answered in affirmative.
The situation for the Danish kroner is very different from the Swiss franc and people that have been speculating a similar move for the Danish kroner are just wrong. Switzerland managed to build a current account surplus that is equal to 12 percent of Swiss GDP, but the Danes are in a very different position, he concluded.
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