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Draghi delivers: top investors on whether ECB’s QE plans will work

Draghi delivers: top investors on whether ECB’s QE plans will work

The European Central Bank today announced plans to finally pull the trigger on its so-called bazooka with a €60 billion-a-month bond-buying programme.

The move will equate to around €1.2 trillion over the course of the programme, which is set to run to September 2016.

Speaking from the central bank’s new headquarters in Frankfurt, ECB President Mario Draghi also set out changes to the Targeted LTRO programme but opted to keep interest rates at their current level.

Questions at the press conference centred on how risk-sharing will pan out and whether the ECB would consider any further measures if the bazooka fails to hit the target.

With that in mind, Citywire Global asked leading investors from Europe and around the globe: do Draghi’s moves go far enough, and will they have the intended effect?

QE cheered but more to be done

Citywire A-rated manager Umberto Borghesi, who is chief investment officer at Albemarle, believes the stimulus effort is positive but will be fruitless if structural reform isn’t followed up on.

Mario Draghi’s measures were expected and had probably already been priced from the market. The decision in any case is satisfying because it demonstrates the ECB gave these issues the right attention and it represents a milestone, following the exhausting negotiations within the ECB, linked especially to German opposition.

We welcome QE as a good start, however we all know this alone is not going to be enough and structural reforms are still very much needed throughout Europe to promote economic growth. 

Size doesn’t matter

Lee King Fuei, head of Asian equities at Schroders, is sceptical over whether the measures can work, as he questioned whether previous stimulus attempts have had positive impacts.

The size of the stimulus is not the issue for ECB QE; the question has to be whether this is an effective measure in the first place. If you look at US QE and we measure it what it has achieved in terms of economic growth, is it a success? I would say no, it is, in fact, a bit of a failure.

We now have the ECB and Japan undertaking QE and they are not faring much better either because there remains structural problems for the economy. The knock-on effect the ECB measure will have is for asset prices to become more skewed  but it is not feeding through to the real economy.

Historical move, but still not all in

Petercam's chief economist Bart Van Craeynest thinks that it’s still highly uncertain whether the meaningful – albeit late – decision would really help the economy.

Finally and about five years too late, the ECB is starting a serious QE program. It is probably too low to have a meaningful effect on the European economy. That said, the promise to buy €60 billion a month until there is a sustained adjustment in inflation indicates the program is semi-open ended and can easily be extended later on.

Disappointingly, for 80% of bond purchases the responsibility for potential losses on the bond holdings is put at the national level. Even if Draghi forcefully downplayed this issue (calling it futile), this still seems like a bad idea.

Up to now the ECB has been just about the only institution that really works at a union-level. For the ECB to recognise that the eurozone is still fragmented is a bad signal for the longer term.

Crucially, Draghi stressed again that in the current climate the ECB cannot create economic growth on its own. Supportive monetary policy needs to be accompanied by structural reforms to get the eurozone out of its current crisis.

Overall, the ECB has delivered on its earlier promise to try to fight deflation, and the door is open to run this program for as long as necessary (which is likely to be much longer than the current intention to run it until September 2016). Whether this will really help the real economy remains highly uncertain.   

Good news for peripherals

According to the JPM Asset Management international CIO for fixed income, Nick Gartside, QE will benefit European high yield and risky assets. But it’s not clear whether it will create good inflation in the long run.

The market had a menu of requirements and Mr Draghi ticked all the boxes. The ECB, along with the Bank of Japan, now take on the role passed from the Federal Reserve as the global providers of liquidity, allowing all asset prices to continue to be supported.

The more open ended language around the inflation target is somewhat surprising and powerful in that it tells you the programme is going to be with us for quite some time in a eurozone context.

Beneficiaries will include European high yield, European peripherals and riskier assets. I think we can expect to see spreads crunch in another half a percent tighter in the periphery, for example.

In terms of doing whatever it takes on inflation, Draghi left unsaid what this inevitably does to the currency, which is potentially dramatically weaken it. You’re looking at the euro likely approaching parity with the US dollar, certainly by the end of the year. 

Ultimately that will bring inflation into the region, but longer-term the question is whether that will be the right kind of inflation, as has been the question in the Japan scenario.  For investors, this reinforces conviction in the peripheral bond market and in the euro weakness trade.

Tough job for the ECB

Threadneedle’s fixed income manager Martin Harvey thinks that the ECB will face bigger challenges than the Federal Reserve or the Bank of England in convincing investors on the seriousness of its policy.

Draghi’s commitment to do ‘whatever it takes’ to combat deflation risk should provide a boost to confidence. His finest hour as ECB President to date was the skilful negotiation of the OMT programme at the height of the euro crisis. QE might not hold quite so much significance in the turbulent history of the euro project, but we should think twice before writing it off.  

With respect to the fixed income market, the commitment should be positive for peripheral country bonds, although we cannot forget the potential for Greek contagion in the short-run. The impact on core bonds is more ambiguous, as any sign that the eurozone economy is not condemned to eternal deflation will make long rates appear very unattractive.

The experience of previous QE programmes suggests that the boost to growth and inflation expectations trumps the demand and supply dynamics if the policy is credible, and yields move higher. The ECB will have a tougher job convincing investors than the Fed or the Bank of England, but in general we see no reason why this would not be the case in Europe too. 

Words followed by action

David Zahn, Franklin Templeton Investments’ head of European fixed income, believes that with this move the ECB has fully achieved its goal.

We have been saying for some time that sovereign QE would be required in Europe and it has now started in size.  We see this as a positive for fixed income markets in Europe, specifically for the peripheral markets of Italy and Spain. 

The QE program should support further spread compression onto the core as liquidity is moved into the system.  In addition, this should lead to a weaker euro over time, helping to marginally boost growth in Europe.  

Although QE does not solve Europe’s structural problems, it does provide support for the structural reform process to continue.  The ECB has shown that it will back up talk with actions, which is important to maintain its credibility.  We believe it has achieved that goal.

Over complication causes concern

Senior portfolio manager Jon Jonsson of Neuberger Berman was pleasantly surprised by the impact of the announcement but believes the ECB has made it unnecessarily complex.

There are three themes we were looking out for and they managed to surprise on the pace and the size which was good, the risk-sharing was a disappointment because we expected that there would be full risk-sharing which there is not.

I think the complexity and the excessive rules are also disappointing but you could argue that is done to appease the German element, to an extent. We were hoping for a simple and aggressive programme with minimal complexity. However, I do think it goes some way to restoring their credibility.

If you look at the headline inflation situation over the past 10 years it has been driven by commodity prices and the ECB cannot affect the oil price, so it has to target a weakening of the currency, which I belief is one of the aims of this.

I expected the 10-30 yield curve to steepen but it has flattened. Draghi said they would consider bonds with a maturity of 2-30 years but if he wants to target the currency, then the front end would make much more sense.

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