For the past few days if not weeks, the global market had been abuzz with the impending QE by the European Central Bank. Some days the market was going up and other days it was going down and people were somehow blaming that on the event. People were wondering whether it will be too small, too late? Experts were also claiming that it is already priced in.
The markets across the continent were sharply up for the year whereas the U.S. indices were down even though it is the current wisdom that the American economy is doing much better that the European.
As of yesterday, January 21, the German DAX and the French CACI were up 5.0% respectively for the year; Spain by 0.5% and Italy by 5.1%. Even UK’s FTSE was up by 2.6%. In comparison, S&P 500 was down by -1.3%, Dow Jones Industrial Average by -1.5%, NASDAQ Composite by -1.4% and the Russell 2000 by -3.2% since the start of the year.
Off course a quantitative easing program by any central bank is hugely negative for its currency and the euro was no exception. It has been on a downward spiral for a long time but it still got a higher gear to go down from the middle of December. For the year EUR/USD is down by -4.0%, EUR/JPY is down by -5.5% and EUR/GBP by -1.3%.
Now that the ECB has announced the plan, let’s try to analyze it. ECB has held the interest rate steady expanded asset by adding the purchase of sovereign bonds to its existing private sector asset purchase programs.
The objective is to, in ECB’s words, address the risks of a too prolonged period of low inflation. ECB is also sticking by its 2% inflation target. Here are some of the rationale for the QE:
- Most indicators of actual and expected inflation in the euro area had drifted towards their historical lows.
- The potential effects on wage and price-setting threaten to adversely affect medium-term price developments
Here are some details:
- Combined monthly asset purchases to amount to €60 billion
- Purchases intended to be carried out until at least September 2016 and in any case until the Governing Council sees a sustained adjustment in the path of inflation that is consistent with achieving inflation rates below, but close to, 2% over the medium term
- The program will run for 21 months and is equal to €1.26 trillion
- Will encompass the Asset-Backed Securities Purchase program (ABSPP) and the Covered Bond Purchase program (CBPP3), launched late last year
- The ECB will buy bonds issued by euro area central governments, agencies and European institutions in the secondary market against central bank money, which the institutions that sold the securities can use to buy other assets and extend credit to the real economy. In both cases, this contributes to an easing of financial conditions
- The actual purchasing will be done by the central banks of individual countries
- ECB will not buy more than 25% of new debt that any country is issuing and no more than 33% of the total outstanding debt
- It will buy bonds with maturities between two and 30 years and with negative yields too
- The hypothetical losses – subjected to 12% of the new purchases – will be subject to loss sharing; ECB will hold another 8% of the bonds; so 20% of the risk is shared and the rest is held by the national central banks
- Debts purchased need to the fulfill the collateral eligibility criteria for marketable assets; the Greek debt is not investment grade but there are ‘some additional eligibility criteria’, hence, is covered; Effectively most of the troubled sovereign assets will be covered
This is somewhat different than what the experts were expecting. The expectations were between €500 billion to €600 billion for maturities less than 30-years.
Here is how the yields look for 10-year treasuries from Germany, Italy and Greece (Blue is German yields and Magenta is Italian).