By Brian Dolan, Head Market Strategist The European Central Bank (ECB) today announced the details of its expanded asset purchase program, Europe’s version of quantitative easing, or QE. (Quantitative easing involves the buying of assets, typically bonds, in an effort to drive down interest rates and supply additional cash to the financial system, and potentially spur lending to the real economy and revive economic growth.)
What the ECB Did
The ECB indicated it would purchase EUR 60 billion. (USD 69 billion) of securities per month, including buying bonds of Eurozone governments. The program largely met market expectations and aligned with prior ECB signals that the program would total EUR 1.1 trillion over two years. The ECB also announced it was lowering the rate on a long-term lending program to banks, adding still further liquidity to the financial sector.
The immediate market reaction has been mostly as expected, with Eurozone and other government bond markets trading higher (yields lower), and risk assets, namely European and other global stock markets, also trading higher on the basis that the ECB is finally taking action and hopefully improving the outlook. European stock indexes are up about 1.5-2.0% in the immediate hours after the announcement. Euro-area government bond yields are down around 10 bps (-0.10%), with yields on periphery (Greece, Spain, Portugal) bonds down even more.
The ECB’s QE program, while large enough to satisfy most market expectations, is still on the modest size in our view, especially when compared with the US Fed’s QE3 program of $85 billion per month. Moreover, we think the ECB is late to the game, with Euro-area inflation already registering negative (i.e. deflation), and economic growth showing stagnation, if not tipping into recession. Japan remains mired in recession/deflation, and Chinese growth remains sluggish (relatively speaking). The US continues to stand out as the bright spot among major developed economies, but may begin to experience more significant headwinds given the global backdrop.
Taken together, today’s events do not represent a game-changing move, but rather a defensive play that may be too late in the game. We would expect fixed income securities to remain in demand for the next several months at the minimum (interest rates stay lower for longer), but the outlook for risk assets (e.g. stocks & commodities) is more mixed, given global economic uncertainties.
In equities, we will be watching closely to see whether the pre/post-ECB gains are sustained, with this week’s close an important signal. The MSCI World Index is testing the top of the Ichimoku cloud on both the daily and weekly charts—a close above may signal further upside potential, while a failure would suggest the best has been seen for now. (See ‘Investing with Clouds’ for more on Ichimoku analysis)
Overall, we remain positive on stocks in general and over the medium-term (multi-month), but would prefer to be adding to long exposures on expected intermittent declines, rather than paying up at current levels. In particular, we would look to begin building exposure to emerging markets outside of Asia, which have shown signs of stabilizing, e.g. Latin America. US shares overall continue to remain appealing, but on a selective, buy-on-dips basis.