The Council of the European Central Bank (ECB) further loosened its monetary policy on 10 March 2016. In view of the decline of the leading economic indicators and the excessively low inflation in the Eurozone, the bundle of measures introduced by the ECB is necessary. But, to paraphrase Mohamed El-Erian, the expansive central bank policy is “ the only game in town”. Effective fiscal policies and structural reforms have been a long time coming. At least the effectiveness of the central bank policies, while it has declined, does still exist.
Last Sunday, the Greek people decided with a clear majority to follow the proposal of their government. With 61.3%, the No camp rejected the conditions of the expired adjustment program. Thereby, Greece is one step closer to an exit from the Eurozone and the European Union.
Bond investors are faced with a difficult environment. Do corporate bonds offer the chance of a halfway decent yield?
Stampfl: The statement that bond investors are faced with a difficult environment is actually an erroneous one. A balanced portfolio consisting of bonds from the peripheral countries and the core countries across all sectors would have seen a very good risk-adjusted performance in the past weeks and months. Also, complementing the BB segment with corporate bonds generates a certain degree of surplus yield, which in funds like Reserve Corporate causes is used to boost the development. That is like switching from winter tyres to summer tyres in spring. It facilitates a smoother running and lower fuel consumption. Or, translating it to the case of the fund, it results in a surplus yield at lower volatility.
The dynamics of the economy and the markets have declined. Global economic growth is down on a quarter-on-quarter basis, the two most important trends of the past months (appreciation of the US dollar and falling oil price) have come to a halt, inflation is not falling anymore, and the US Fed has put a damper on the expectations of interest hikes. One important exception: the Eurozone has been picking up speed.
The US central bank, the Fed, is very likely – almost 90%, according to Fed funds futures – to raise the Fed funds rate this year. The expected rate hike has been one of the dominating topics on the financial markets for a year. The bursting of a mega bubble, rising pressure on fragile emerging markets, and the end of years of a share market rally in the USA are the most commonly mentioned worries in this context. None of which is overly far fetched, as we have indeed seen all of these scenarios before. Still – history prompts the conclusion that there is no need to panic, at least not when it comes to equities.
We have seen European equities outperform their American peers in the year to date, both in local currency and in euro. Not even the increase of the US dollar relative to the euro of 8% made a difference to that. What is this pro-European optimism based on? After all, the US economy has seen a significantly better development than the Eurozone. The same is true for US companies, which have been recording profit growth, as opposed to Europe, where profits have generally been falling recently. The uncertainties in Greece and Ukraine only add to this scenario.
The driving topics on the financial markets are the stabilisation of the oil price, mixed economic indicators globally vs. positive economic indicators for the Eurozone, the temporary decline in escalation risk, and the expansive central bank policies.
Since the cutting of key-lending rates to almost zero in the Eurozone did not suffice to keep the inflation expectations at their long-term target of slightly below 2%, the ECB Council decided in January to expand the central bank money supply until the accomplishment of the target was foreseeable.
The possible effect on the financial market and the economies are multi-faceted. 1) The excessively low inflation expectations increase. This will cause real interest rates (i.e. nominal interest rates minus inflation) to fall. 2) The currency (i.e. the euro) depreciates vis-à-vis other currencies. 3) A so-called asset price effect is created. The ECB buys bonds with low yields, resorting to the central bank money supply. This keeps bond yields very low (partially even negative). Given that, and because the volume of government bonds investable by the private sector shrinks, investors are pushed into asset classes with higher expected yields (bonds with long maturities, bonds with higher default risk, bonds with higher coupons in a foreign currency). This crowding-out effect supports asset prices. The net worth of the holders of these asset classes increases. 4) The willingness of banks to grant loans is supported by the very low bond yields.