The good, the bad and the ugly for the ECB

by

18 Nov 2014

In the first of a two-part series, Emma Cusworth looks at how the European Central Bank’s decisions are affecting investors.

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In the first of a two-part series, Emma Cusworth looks at how the European Central Bank’s decisions are affecting investors.

In the first of a two-part series, Emma Cusworth looks at how the European Central Bank’s decisions are affecting investors.

“If Draghi can’t push full blown QE through, it would take markets back to how they were prior to his 2012 speech.”

Stewart Richardson

Churchill famously said: “You can always count on Americans to do the right thing – after they’ve tried everything else.” Today, the same has been widely said of the European Central Bank (ECB). Two notable assumptions underlie these statements: firstly, the necessary steps will be avoided until they become absolutely imperative, which, secondly, means a crisis point must first be reached.

While the eurozone is unlikely to see a crisis comparable to Pearl Harbour, things will get a lot worse before the various fighting factions behind ECB policy finally get on with the full-blown quantitative easing (QE) that looks increasingly inevitable.

“The eurozone has gone from the nadir [at the height of the crisis] of looking like it was going to blow up in around three months to a widespread belief the region was in a self-sustaining recovery during the last nine months,” says Tapan Datta, global head of asset allocation at Aon Hewitt. “ Today it has sunk to a dramatically different set of views.”

The problem facing the ECB and its president, Mario Draghi, is that every day that passes means the solution to the next 40 | portfolio institutional | December 2014 | Issue 41 Issue 41 | December 2014 | portfolio institutional| 41 impending crisis has to be all the greater to produce the same kind of result as the Federal Reserve (Fed) achieved with its extensive bouts of QE. And, if that is the case, the in-fighting within the policy setting committee could see things get pretty ugly.

THE GOOD…

The last eurozone crisis apparently ended the day Draghi promised to “do whatever it takes” to save the euro in July 2012.

After peaking at 56.34 in September 2011, the VStoxx index, which measures the volatility of the Euro Stoxx 50 index, bumbled from peak to peak, hitting 38.31 in early June 2012 and 28.68 on 25 July 2012. Following Draghi’s speech on 26 July, the VStoxx fell into (generally) more benign waters, bottoming at 12.3 in mid June this year.

Then began a raft of bad data which showed, according to Kenneth Orchard, portfolio manager, European Fixed Income at T Rowe Price, that the slowdown in the last few months was happening “faster than anticipated”.

By mid-October, the VStoxx was back up at 36, despite two important developments in ECB policy in September and October, which saw Draghi overshoot expectations by cutting the main refinancing rate to 0.05% from 0.15%, and an asset purchasing programme of asset-backed securities and covered bonds to be started in October to spur issuance of the targeted long-term refinancing operations (TLTRO).

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