Commentaries

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.

Download the full PDF

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.

Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.

Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2015 Envestnet. All rights reserved.