February 6, 2015 Playa 8
Finally, after months of fretting by investors, they got what they so desired from the European Central Bank, and more. At the end of last month, the bank at long last decided to show all its cards and announced a full QE program, in addition to the massive credit issuance measures previously put in place. The monetary authorities will be unleashing an additional €60 billion each month into the markets. They will be buying bonds from this coming March through September 2016, or until they are satisfied that inflation is set to reach and stabilize at the official target of just under 2%.
Basically, 20% of the bonds will be purchased by the ECB and the rest will be bought by the different national central banks (NCB’s). Sovereign bonds of all member countries of the Euro Zona, with a credit rating of BBB-, or investment grade, will be eligible to be purchased. Banks can own up to 33% of any one country’s bonds, meaning the risk of default will be shared by the ECB and all member countries through the NCB’s, which raises the question of the point of a monetary union, but that’s another, more philosophical matter.
The first response by the markets, of course, was the euro’s dive – it dropped like a stone versus all other currencies, especially the US dollar. It means that a huge amount of euros will be printed and injected into the world market, increasing supply; and it also means that the Euro Zone’s economy is in trouble, and in higher risk of falling into recession, so it is less attractive as an investment target. In parallel, European bond rates also fell in anticipation of demand for these securities, which will make their prices rise.
But the next stage of the response was not as fully expected, and it’s been a series of benchmark rate easings by a host of different countries, like Canada, Denmark, Switzerland, Russia, China, Singapour, India, New Zealand, Australia, or Colombia, and the threat of further easing by others, like Sweden, Thailand, Malaysia, or Brazil. All of these countries are watching their economic prospects deteriorate, as inflation drops out of site.
Clearly, aside from the US, the world is still quite ill, with weak economic growth in many, many countries, and a sort of race in place, to lower interest rates and depreciate currencies, looking for the spark that will ignite activity. Unfortunately, at this point, success is uncertain, to say the least.
The good news, however, is that governments and central banks are doing something about it. Let’s just hope that if things start looking up, authorities won’t feel so comfortable that they will let down their guard regarding economic and financial reform.
So, for now, among the confusion, volatility is the name of the game in the marketplace, which makes for a very difficult environment in which to design a smart investment strategy. Our best advice at this time, then, is to be patient, because this amount of turbulence usually doesn’t last long.