€60b per month, starting in March and running through to September 2016, consisting of purchases of sovereign and private-sector securities with durations of 2 to 30 years for the former regardless of yield. Securities must be investment grade, some exceptions will apply to nation’s part of an EU/IMF program, with purchases to be conducted by National Central Banks (NCB’s) under the oversight of the European Central Bank (ECB). Purchase quantities will be based on the share of an individual Central Bank’s capital held at the ECB. NCB’s will assume the individual risk of sovereign bonds purchased with 20% of assets, largely private-sector securities purchased, subject to loss sharing between NCB’s and the ECB themselves. While scheduled to run until September 2016 purchases will continue until the ECB see ‘a sustained adjustment in the path of inflation which is consistent with (their) aim of achieving inflation rates below, but close to, 2% over the medium term’.
That, in the most condensed form possible from a sleep-deprived market strategist, outlines the announcement made by the ECB overnight to expand their balance sheet, including, for the first time, outright sovereign bond purchases. So, to the €1.14b plus question. Will the program have the desired effect on boosting medium-term inflation expectations? In the short-term the answer is yes, thanks primarily to the impact of the weaker Euro. However, in this era of currency wars, the answer for the medium-to-longer term is far less certain.
In essence the ECB’s decision overnight will make it harder for the US Fed to hike rates later this year due to the continued appreciation of the USD. Disinflationary pressures are already evident in the States, will the Fed actually amplify those pressures by tightening policy when other major central banks are easing? In my opinion, unless the US economy can absorb the USD impact and continue to strengthen, the likelihood of a rate hike in 2015 appears remote. Yes, there’s a chance QE could help spur European growth therefore strengthening the global recovery but, looking at how other major economies fared during the era of US QE, this wasn’t the case, in fact it was quite the opposite.
So, pricing in the increased likelihood that the Fed will not move rates this year, something that will limit downside pressure on the Euro, what are the chances that European governments will use ultra-easy monetary conditions to implement pro-growth reforms, something that is by far the more desired option to spur inflation expectations over the medium-to-longer term? Unlikely is the honest answer based off evidence seen since the ECB began their current easing cycle. Why make tough reforms that could jeopardise your chances of re-election when you have a central bank who, while asking for action, continues to expand their involvement to make up for political inaction elsewhere? It’s a cycle that has been ongoing since the start of the European financial crisis and will only likely continue.
So what will the expanded ECB asset purchase program deliver? Increased borrowing from the private-sector? Demand is hardly strong despite record-low interest rates seen recently. Household’s don’t want it (or can’t get access to it) and corporates won’t need it unless economic conditions improve. So where will funds end up? High-yielding financial market assets is the likely answer. If demand from the real economy isn’t there it’s only natural that it will find its home elsewhere. Whether this large-scale leakage into financial markets will deliver the ECB’s desired outcome, increased medium-term inflation expectations, is highly debatable. Did it occur for the Fed or BoJ following their asset purchase programs? The fear among many is that it will simply spur asset bubbles. During his press conference ECB President Mario Draghi suggested that he doesn’t see asset bubbles at present. A statement, when looking at the recent performance of European periphery stocks and bonds, is hard to fathom given economic conditions within the Eurozone are so weak that the ECB decided to take this action. Only time will tell if it will indeed improve conditions within the European economy to justify current valuations or simply add to financial imbalances that are, in my opinion, already evident at present. While I may be sceptical, for the sake of the global economy in the years ahead, let’s hope that I will be made to eat humble pie.
For all those who’d like to read the full ECB statement or full details of the asset purchase program please follow the links provided below.
Details of the expanded asset purchase program:
In the second time in a week Denmark’s Central Bank lowered benchmark deposit rates, this time in response to the ECB monetary policy decision made overnight. Rates were cut by an additional 15bos to -0.35%.
US initial jobless claims fell by 10k to 307k last week. The reading, below expectations for a decline to 300k, left the 4-week series average, a better overall gauge that strips our week-to-week volatility, at 306.5k, higher than the 298k level reported previously.
US house prices logged their largest monthly increase since December 2013 in November with the FHFA house price index jumping 0.8%. The reading left the annual pace of growth at 5.3%, higher than the 4.5% increase of October.
UK manufacturing orders grew at a fractionally slower pace in January with the CBI’s order balance falling to +4. The decline, below the +5 level of December, was amplified in expectations for the coming quarter with the order balance falling to +11, the lowest level recorded since October 2012.
Poor industrial data out of Italy overnight with both orders and sales slumping in November. Orders fell by 1.1% leaving the annual rate at -4.1%, the largest decline seen since August 2013, while sales dropped 0.6% with the annual contraction accelerating to 1.6%. Completing a weak data set retail sales grew by just 0.1% over the same time period with the annual rate sliding to -2.3%, the largest decline reported in the past three months.
Spanish unemployment rose unexpectedly to 23.7% in Q4. The reading, higher than the 23.67% level of Q3 and forecasts for a decline to 23.5%, was the first quarter in three that an increase had been recorded. Underneath the hood the data was mixed with net employment increasing by 65,100 from Q3, something that left the annual gain at 2.53%, although, partially offsetting that, unemployment also increased by an additional 30,100 persons.
The Day Ahead (AEST)
The ASX 200 looks set to end the week on a high with SPI futures pointing to a rise of 64pts on the open. Falls in crude oil and iron ore (the latter has now fallen 50% from the beginning of 2014) will likely be ignored with broad-based gains likely led by the financials sector.
The AUDUSD has been slapped lower in the period following the ECB rate decision with broad-based USD strength weighing on the Aussie. Having briefly dipped below .8000 this morning, the first time it’s displayed a 7-handle since July 17, 2009, the pair has now recovered slightly to currently buy .8018. While it is short-term oversold with Chinese economic data incoming, something that suggests the potential for a squeeze, it’s likely that the pair will remain under pressure with any substantial bounce in Asia likely to be sold into. Resistance is layered between .8050 to .8080 with support, for now, located below the .8000 level.
Regional data releases today include manufacturing PMI gauges from China and Japan, South Korean Q4 GDP along with Singaporean CPI. Later in the evening we’ll also receive flash manufacturing PMI gauges from the US, Eurozone, Germany and France, existing home sales, Chicago Fed national activity index and the latest leading index from the States, CPI and retail sales from Canada, UK retail sales along with Italian international trade.
Greek general elections will be held on Sunday. While it looks like Syriza will win based off recent polling, I expect there’ll be more attention on the matter next week as they attempt to form a minority government.