While some tilt their European portfolio weighting towards equities in anticipation of a European Central Bank splurge on government bonds, Thursday’s policy meeting ended with what can at best be described as another sprinkling of QE breadcrumbs.
But is that really so much of a disappointment?
Speaking to Portfolio Adviser, Expert Investor Europe’s sister publication, Jones outlined why investors need to take a step back and see the wider picture.
“What most people mean by QE is aggressive, blunt purchases of European sovereign government bonds,” he said. “My reaction is that I am not quite sure that the ECB will go and do that – bonds are already at exceptionally low yields.
Dream on, investors
“Everyone is thinking that Draghi is going to buy five-year bonds at 14 basis points of yield in Germany and 27 in France – I mean, what is the point?”
“The market is desperate to get to a point where the ECB goes and buys government bonds like that will be the answer to everything. That blunt measure is unlikely.”
It is widely acknowledged that there has already been a form of European QE in motion for some time, in the form of what has been described as a ‘drip-feed’ policy.
For this reason, Jones emphasised that the ECB is unlikely to take any further action.
“Investors and commentators are asking ‘will they do QE?’,” he explained. “They are doing QE, but in a more targeted way. They might buy more corporate bonds themselves to help that process along, but QE is already in operation in the asset-backed and covered bond markets.
“From the ECB’s point of view, maybe it is better to lead the market along and say ‘we’ll do it in January, we’ll put some more staff papers together, we’ll adjust forecasts, we’ll have a debate over whether it is acceptable to the council to do it’ and at the same time get the benefit of lower bond yields.
“The ECB has already done quite a lot. It has cut interest rates on deposits and provided the banking sector with a pretty aggressive liquid injection in LTROs. It has been happy to see the currency devalue quite markedly, which will be good for promoting export demand and raising inflation a little off the low and concerning levels that it is at.”
Transformed memories
While QE has had a positive effect in the UK and US, Jones’ view is that people’s memories of the impact it had on those economies has been distorted.
“Draghi himself said that QE had worked in the US and the UK,” he said. “It is sitting in those Anglo-Saxon economies with employment being created and ongoing economic momentum. But it didn’t manifest itself in aggressive bull markets in equities – that has come off the back of the delivery of earnings and attraction of dividend cash flows and equity income as people realised that cash rates were not going to go up for a long time to come.
“The same will be the case in Europe. You will only get a significant outperformance out of European equity through delivery of earnings. Earnings are definitely supported by QE, but ratcheting up from their current levels will take a little longer than just the announcement day. So those wanting to play QE through earnings, even if it is delivered, will have to wait a longer time.”
But why is the ECB-president promoting the idea of monetary easing and leaving himself open to criticism in the media and the market?
“You have to say that Draghi has played a series of very good hands,” Jones explained. “He has not only managed to stabilise the outlook in opinions surrounding the currency, but he has been able to put in place real stimulus for the economy. It remains to be seen whether he can put QE in place, but overall his impact on markets is still believed in and very strong. I can’t see anything derailing that.
“We are not living in easy or pleasant times, and it is very is easy to say ‘he should do this’. But what the financial market, investors and politicians have to deal with is reality, and that is often manoeuvring around the least bad option. Draghi has done a good job around that angle.”
Despite everything, Jones acknowledged that there are certain risks entailed in the ECB not living up to market expectations. “The risks of not doing QE are in the periphery around very low yield levels in Spain, Portugal and Italy,” he warned. “Yields that are not really justified by the quality of debt in terms of sovereign credit risk, but have been supported on the notion that someone was going to come in and buy lots of their bonds. If that does not happen then Italian government bonds in particular are very vulnerable, because the economy is not that strong and the very high debt to GDP ratio it has to support does not justify the yields.”
