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Economic Insights

Market action following the ECB meeting on September 8 echoed a similar U.S. Fed-inspired sell-off in 2013. But investors may be misreading the ECB’s intentions regarding quantitative easing. 

 

In Brief

  • The European Central Bank’s (ECB) September 8th statement suggested a more laissez-faire attitude toward monetary policy than investors expected. Markets sold off in the immediate aftermath.
  • But investors may be getting ahead of themselves. ECB president Mario Draghi realizes the importance of a gradual, well-communicated process in altering policy, and, therefore, a reduction in bond purchases is not likely.
  • Ultimately, the ECB’s intentions may be much less hawkish than investors fear. Draghi’s comments on September 8 suggest elements of a more inclusive and extended program of asset purchases.
  • The key takeaway—For the ECB and other central banks, it seems unlikely that “lower for longer” monetary policy will shift anytime soon.

 

The European Central Bank’s (ECB) statement on September 8, and ECB president Mario Draghi’s subsequent news conference, suggested a more laissez-faire attitude toward monetary policy than investors expected. The lack of a clear enhancement or extension of the ECB’s bond-purchase program disappointed investors who were hoping for some assurance that the central bank’s largesse would continue beyond the program’s intended “soft close” of March 2017. Any assurance was buried in opaque ECB language and indirect Draghi commentary; investors responded by selling securities, whose prices softened in Europe, Japan, and the United States. 

Similar to, but less dramatic than, the “taper tantrum” surge in U.S. Treasury yields following U.S. Federal Reserve (Fed) chairman Ben Bernanke’s May 2013 suggestion of reduced bond purchases under the Fed’s quantitative easing (QE) program, investors, nonetheless, sent a familiar message: Without central bank purchases, investors have less appetite for securities at current prices.

Lessons Learned
While prices of both bonds and stocks moved lower in the immediate aftermath of the September ECB meeting, the impact is likely to be far less than the 2013 taper tantrum, when panicked investors moved the U.S. 10-year Treasury yield, from about 1.7% in May 2013 to more than 3% by year-end (based on Bloomberg data). 

Why? The fact that investors have previously experienced the Fed’s reduction in QE, and that Mario Draghi has had the opportunity to observe the Fed’s 2013 strategy dealing with a similar situation, should temper both policy actions and market reactions. Investors have learned that the reality of reduced central bank purchases was worse even than their initial expectations; Draghi no doubt has learned the importance of a slow and well-communicated process given the perceived importance of the ECB’s purchases. 

After absorbing the lessons of the 2013 policy shift in the United States—one far more dramatic than what the ECB seems to suggest in 2016—investors and policymakers should adopt a more balanced approach this time. More important, it is likely that the ECB has no plans to reduce bond purchases yet.

Between the Lines
Unlike the 2013 taper tantrum, investors’ response to the ECB was not panic about an overt policy shift to reduced purchases but instead concern about the absence of clear language to extend the ECB’s bond-purchase program. Perhaps even this was an overreaction. Draghi’s comments imply an intention to extend asset purchases, although with perhaps with less enthusiasm than investors wanted. Draghi offered that “we will preserve the very substantial…monetary support that is embedded in our staff projections and that is necessary to [return inflation to] …2%.” It sounds as though monetary support via asset purchases will likely continue. 

Draghi further implied that program restrictions that limit execution of asset purchases could be relaxed: “The [ECB’s] Governing Council tasked the relevant committees to evaluate options that ensure a smooth implementation of our purchase program.” This may suggest that in order to assure continued securities purchases, the yield restriction of -0.4% could be relaxed, issue and issuer limitations could be expanded, or constraints could be eased to allow increased purchases of peripheral country debt. 

Ultimately, ECB intentions may be much less hawkish than investors fear. Elements of a more inclusive and extended program of asset purchases seem to be buried in the communications of both Draghi and the ECB. 

Looking Forward
The decline in equity and bond prices after the ECB policy announcement on September 8, and Draghi’s subsequent press conference, may be an overreaction to softer language regarding the continuation of QE. For the October ECB meeting, expectations may build for an explicit relaxation of constraints limiting bond purchases and the defined extension of the ECB’s bond-purchase program beyond March 2017. Draghi’s comments on September 8 seem to imply that both actions are under consideration.

It seems unlikely, however—especially after the self-congratulatory comments from global central bankers at the Fed’s Jackson Hole, Wyoming, symposium in August—that “lower for longer” monetary policy will soon shift. Instead, it looks increasingly likely to be joined by some form of fiscal-policy moves in major economies, as Germany discusses tax reductions, the United Kingdom entertains a cut in its value-added tax (VAT), and as hopes grow in the United States for increased infrastructure spending (the likelihood of which won’t become apparent until after the November elections). The prospect of monetary policy and fiscal policy working together in 2017 could create a substantially different economic and investment environment than what is implied by the market’s current reaction to the ECB’s latest policy announcement. 

 

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