PMC Weekly Review - March 13, 2015

A Macro View – The European Central Bank Begins Buying Bonds

On Monday, the European Central Bank (ECB) kicked off its widely anticipated quantitative easing program of bond buying. The goal of this program is to help fulfill the ECB’s price stability mandate and to stimulate Europe’s economy, which has been experiencing low growth, low inflation, and high unemployment. This program, which had been announced by ECB President Mario Draghi in January, is focused on buying sovereign bonds of euro area central governments. The ECB has said that it expects to increase its bond purchases to a €60 billion euro level each month through at least September of 2016 (buying at least €1.1 trillion worth of bonds along the way). With that, bond buying is expected to continue until the ECB sees inflation move towards its medium-term goal of 2%. The rationale behind the bond buying is that this will further ease monetary conditions in Europe allowing firms and households better access to cheaper financing. In addition, such a move is expected to devalue the euro providing European exporters more competitive pricing in foreign markets. This is expected to help support investment and consumption which will ultimately lead to the return of inflation rates closer to 2% along with a healthier economy. For their part, the BBC (British Broadcasting Corporation) cites that the ECB has raised its forecast for economic growth in 2015 to 1.5%, from 1% in December.

The impact of the European quantitative easing was felt immediately during the week as new bond buying has further driven up bond prices and correspondingly lowered yields even more. One of the surprises in the ECB statement is that the bond buying wouldn’t be limited to just the front end of the yield curve, but all maturities would be eligible. This had the effect of pushing down short, intermediate and long term rates across the Eurozone. With that, the yields on the sovereign debt of Germany, France, Italy, and Belgium have recently hit all-time lows. According to Bloomberg, Germany’s 10-year Bund was down about 17 basis points and was yielding a meager .23% earlier this week. Meanwhile, Italy’s 10-year sovereign debt was offering a 1.21% yield. These yields are significantly below that of the 10-year U.S. Treasury yield, which had recently been at 2.13%. Furthermore, many shorter duration European bonds have actually been offering negative yields. German 2-year Bunds were at -0.24%, while their 5-year counterparts were at -0.13%. There have also been impacts on some non-European Union countries as Swiss 10-year sovereign debt was recently trading at -0.14%. All in, according to the Wall Street Journal, Morgan Stanley estimates that approximately $1.5 trillion in global sovereign and corporate debt trade at negative yields.

With that, investor funds have been flowing into riskier assets that have potential for higher yields and/or returns. Bank of America Merrill Lynch cites that roughly $1.8 billion has been added to emerging market debt funds during late February and early March. Others note that European stocks may also continue to benefit from ultra-low interest rates. With that, the Stoxx Europe 600 Index has been up about 15% this year. Frankfurt’s DAX was up even more, at 18% year-to-date. However, the strong U.S. dollar has given U.S.-based investor returns a haircut and global bond index returns have been negative for U.S. investors this year.

Finally, the quantitative easing (along with other developments such as the potential for Greece’s exit from the Eurozone) has helped move the Euro’s value down significantly and Reuters is now reporting it is at a 12-year low versus the U.S. dollar, having dropped another 12% this year after previous declines in 2014. The Euro has been moving nearer to trading at parity with the greenback ($1.06) this week and some believe that parity may be hit (or the Euro even drops below $1.00) as the European Central Bank’s €60 billion in monthly purchases gets under way, though currency moves are generally difficult to forecast. The euro is also trading at low levels against other currencies as well, as it fell to a seven-year low versus England’s Pound and an 18-month low versus the Japanese Yen. Finally, the U.S. dollar has risen very quickly and significantly versus a broad basket of currencies around the globe due to a flight to quality and as investors search for more compelling yields as the U.S. Fed weighs the prospects of actually raising interest rates.

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