GLOBAL equities rallied sharply last week, with most of the gains coming after the European Central Bank (ECB) president, Mario Draghi, spoke on Thursday. There was nothing in Draghi’s statement that had not been telegraphed to the markets in advance. Nevertheless, investors piled into “risk assets” as the ECB president backed-up his earlier promise that the central bank stands ready to “do whatever it takes” to save the euro. However, it is worth noting that the new Outright Monetary Transactions (OMT) programme is not like the full-blown quantitative easing programmes of the US Federal Reserve, Bank of Japan or Bank of England. Rather than adding liquidity, OMT just shifts it around. Although future ECB bond purchases are potentially unlimited they will be sterilised, which means, for example, that the ECB can sell German debt to buy Spanish debt. This should be a concern to those stronger members of the Eurozone, as it means that their bond yields will rise if the ECB acts aggressively to suppress the debt yields of vulnerable countries.
Conditions will be attached to any country that receives this form of aid. Draghi stated that the ECB would stop buying bonds if the subject country fails to meet its targets and thereby breaks conditionality rules. So there is an implicit limit to these “unlimited” purchases. But what happens to yields if the ECB suddenly stops buying a troubled country’s bonds? No doubt Draghi is hoping that the ECB’s resolve will never be tested.
Mark Grant, author of the popular Out of the Box market commentary, made a number of interesting points about the ECB’s latest statement. He notes that countries have to request a bailout which has to be agreed to by the EU, and perhaps the IMF, too. The country requesting a bailout will then be subject to an “outside” audit. This audit may show that the country’s finances (and those of its banks) are in a worse condition than its own official numbers indicate. This was the case for Greece, Ireland and Portugal, and there is no reason to think that Spain or Italy will fare any better. Grant believes that this could be the reason why Spain has resisted asking for a full bailout so far.
Secondly, the ECB has said it will not activate the OMT without the approval of the stabilisation funds (the European Financial Stability Facility and European Stability Mechanism). Grant makes the point that there are countries within the Eurozone (such as Austria and the Netherlands) that could refuse any further requests for help. Consequently, wrangling and arm-twisting to force agreement from all Eurozone member countries could scupper ECB bond purchases.
We shall see. Of course, a formal request for help implies loss of sovereignty – something that will not go down well with Spanish citizens, just as it is not going down well in Greece.
On Friday, we saw the latest US non-farm payroll numbers. The dismal sub 100,000 reading, together with a substantial downward revision to the prior month’s data, has boosted expectations that the Fed will announce further stimulus measures on Thursday at the conclusion of its two day meeting. One of the main headlines from Ben Bernanke’s Jackson Hole speech was that the Fed saw the stubbornly high level of US unemployment as a “grave concern”.
Additionally, members of the US Federal Reserve, including chairman Bernanke, have indicated that monthly payroll growth below 100,000 would be a problem for the central bank as it impinges on its mandate to maximise employment. The question now is whether the Fed waits to see if this weakness persists, effectively closing the window for QE until after the presidential election, or if they take decisive action now.
So, no pressure, Ben. But is another controversial round of quantitative easing really justified when US equity markets are trading at multi-year highs and bond yields are close to record lows?