Chief Investment Strategist and Chief Economist
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After a round of “communications failures” in late 2015, the ECB and its President Mario Draghi appeared to work hard to exceed market expectations with policy actions today.
Details (warning, this section is complicated)
- In a wide-ranging package of steps, the larger surprises included the ECB adding non-financial investment grade corporate debt to its asset purchase menu. The overall purchase pace has been expanded to €80 billion per month from €60 billion, or about 9% of Eurozone GDP annualized. The ECB cut its deposit rate 10 basis points to -0.40% and now doesn’t expect further cuts, but will rather focus on other unconventional easing measures. On this latter point, reduced expectations for further rate cuts appear to have caused a weakening in the German bund market today. A consequent negative spillover to world equities is a head scratcher. (I.e. Didn’t market participants claim to fear the consequences of negative interest rates?)
- The ECB expects to launch new “targeted” long-term refinancing operations (TLTROs) with a maturity of four years in June 2016. It said these could include an interest rate as low as the deposit facility (- 0.4%). These new liquidity facilities for banks will replace maturing operations.
- The TLTROs were also likely added to offset market concerns about negative interest rates on bank profitability and future lending activity. In his press conference, Draghi even called attention to potential protections for certain European subordinated bank debt holders in the future.
- Financial market volatility spiked on the ECB’s surprise, which doesn’t settle the issue of predictability for the central bank. The Euro, surprisingly, jumped in value despite an outlook for very sustained base money creation (at a faster pace relative to GDP than seen during the heart of the U.S. Fed’s last QE steps). We are doubtful that an upward revision to deposit rate expectations in the Eurozone can alone account for the large positive move in the Euro (+1.7% vs USD).
Takeaways (simple, we hope):
- We don’t believe monetary policy drives long-run real economic growth. Confidence has always played a role in the efficacy of monetary policy in influencing asset prices and any demand impact. This was seen in the extraordinary efforts during 2008/2009 to do more than “push on a string.”
- In a “liquidity trap,” changes in base money are meaningless for asset prices. However, we don’t believe the Eurozone is in a pure liquidity trap. Rather, data show significant short positioning in the Euro already, a condition that ECB easing over the years ahead will likely outlast.
- In the current market context, we believe “fast money” investor positioning has much to do with market reaction to the ECB’s steps today. Assessing the lasting market impact from these steps will take time, just as market euphoria on the day of the Fed’s December 16 tightening step was very fleeting (+1.5% that day for US shares, negative thereafter).