Draghi’s ‘Powerful Signal’

For months, analysts scrutinized every word uttered by Mario Draghi in hopes of divining if—and when—the European Central Bank would announce quantitative easing measures aimed at boosting growth and forestalling deflation.

For months, analysts scrutinized every word uttered by Mario Draghi in hopes of divining if—and when—the European Central Bank would announce quantitative easing measures aimed at boosting growth and forestalling deflation. The ECB president finally put the conjecture to rest last week by making an ambitious commitment: it will henceforth purchase 60 billion euros in bonds every month from March through at least September 2016.

And just like that, another “new era” of European monetary policy has begun. What will it look like? Consider the bond market. If recent market moves are any indication, holders of European government bonds are in for a rough ride. Yields on most bonds—from German to Spanish 10-year notes—have been falling for months as buyers snapped them up in anticipation of QE, and have fallen even more since Draghi’s announcement. That limits the potential for further gains and, even though seeking to resist the impact of ECB purchases is not a strategy favoured by Credit Suisse, it does expect profit-taking by some investors: “You’re not going to make a lot of money holding these bonds to maturity,” says Neville Hill, co-head of global economics and fixed income strategy at Credit Suisse.

And then there’s the euro itself. Credit Suisse, already regarded itself as a “long-term euro bear” before Draghi’s move, calls the QE program “far-reaching enough” to prompt another downward revision in its forecasts to 1.09 euros per dollar in three months and 1.02 in 12 months (the euro has already fallen 7 percent this month to 1.13 per dollar). That call stems from the fact that by next September, the ECB plans to have increased the size of its balance sheet by half — from 2 billion euros to around 3 billion euros; and at the very same time that the U.S. Federal Reserve’s balance sheet is shrinking.

What’s more, the bond-buying program is more ambitious than the market had expected, both in terms of the amount and pace of asset purchases. That may have provided shock and awe at the outset, but it has negative longer-term implications for the currency, and even includes some elements that leave the euro exposed to further depreciation in the future. The ECB’s program open-ended, for example, and it has promised to continue with its purchases past next September if inflation isn’t accelerating towards the bank’s 2 percent target.

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