Well, the Earth did not stand still and markets were relatively rational as President Draghi unveiled a “genuine” QE program. It was a variation of yesterday’s leaks except the final amount was larger than what was rumored. The ECB will be financing the purchases of a mix of asset-backed securities and sovereign bonds to the tune of 60 BILLION EUROS every month from March at least until September 2016. The QE program is open-ended in that the ECB will reserve the right to continue purchasing more assets with printed euros if the inflation target is failing to rise to the 2 percent target level. The European equity markets were unchanged and the BUNDS and French oats fell until President Draghi assured the markets that the ECB would even purchase credit instruments with a NEGATIVE YIELD.
When Mr. Draghi clarified that issue, BUND futures reversed and had a sizable rally. However, Italian BTP futures were the star performer of the day as investors were comforted by the QE plan and began buying the higher yielding sovereign bonds, leading to a further compression in the yields between German debt and peripheral sovereign paper. The ECB paid homage to Chancellor Merkel and Bundesbank President Weidmann by limiting the amount of shared risk that the central bank will be responsible to underwrite.
All in all, the markets were content that Draghi delivered a robust monetary stimulus program. The ECB also assured the bond markets that its debt purchases would be “pari passu” with other bond owners rather than taking a more senior position in case of a default by one of the national central banks. Draghi even noted that there would be no “special rule ” for Greece and the ECB would be able to purchase Greek debt by July. Draghi reiterated that the QE program was a necessity because the ECB mandate is price stability and the ultra-low inflation left the bank far from meeting its responsibility.
The problems for Europe are now political. Will Spanish voters be placated by the wealth effect of rising stock prices if the economy fails to grow fast enough to create jobs? The left in Spain is gaining electoral strength and if the Greeks vote in Syriza and its leader Alexis Tsipras pushes for debt cancellation, the Spanish Podemos Party will also seek some type of debt relief to ease the pain of Brussels-imposed austerity. If the wealthy in France are the only beneficiaries of QE because of rising real estate and stock prices, Marie Le Pen will continue to threaten the political mainstream. Bernanke’s PORTFOLIO BALANCE CHANNELwas successful in halting a deflationary default spiral but it was working with a unified political, fiscal and banking system (and the success of the PBC is still only a questionable success).
The question to be asked: WHO DOES THE ECB QE PROGRAM PUNISH? In deference to the work of Professor Carmen Reinhart, central bank and government programs meant to artificially suppress interest rates always repress savers (in this case, Germany). The Germans are not debtors but savers, thus the enormous German trade and current account surpluses. Many in Europe will cheer that the German citizens and Chancellor Merkel, who foisted severe austerity budgets upon the Greeks, Spanish, Irish and Italians, are going to be the recipients of financial repression as real yields in Germany turn negative. It was Bundesbank President Weidmann who maintained that the EU was not experiencing deflation for German CPI was 0.8%. The BUND is yielding 50 basis points, resulting in a negative real yield of 0.35%. When the ECB purchases commence German yields may fall further. This will not be the Fed’s QE for there are far more moving parts in the EU financial and political systems.
***A FUNNY ASIDE: Draghi began his press conference 10 minutes late because he said he was caught in the elevator which made me think that maybe the “Earth Stood Still” in a warning from the Bundesbankers who voted against the Draghi Plan.