I don’t know if Mario Draghi’s “historic” quantitative easing program announced Thursday will do anything to help the flat-on-its-back euro zone economy.
I’m not a trained economist, so I’m not sure exactly how buying massive quantities of already overpriced bonds is supposed to raise inflation and boost the economy, although it has been very successful in devaluing the grossly overpriced euro. But how is a cheaper currency going to help countries in the euro zone when they do most of their trading with each other?
What I am sure of is that the program will make U.S. Treasury and corporate debt securities a lot more attractive to investors, further lowering long-term interest rates here, and giving our economy, now the envy of the rest of the world, another boost.
It’s about time Europe did something for us.
The immediate effect of the European Central Bank’s new QE program – in which it said it would be buying €60 billion ($69 billion) a month in assets, including government bonds, debt securities issued by European institutions and private-sector bonds, the vast majority of the purchases comprising sovereign debt, and possibly for as long as it takes to work – was to drive down the yields of euro zone sovereign bonds to even lower record lows.
The yield on 10-year German bunds dropped eight basis points on Thursday to below 0.40%. Yields on comparable Italian and Spanish bonds dropped about 14 bps, to 1.55% and 1.40%, respectively. Even yields on Greek bonds, which are ineligible for ECB purchase at least until July – a carrot for Greek voters before Sunday’s parliamentary elections, perhaps – dropped 40 bps to below 9%.
By contrast, the yield on 10-year U.S. Treasuries ended the day largely unchanged at 1.88%. That gave the U.S. T-note a yield premium of 148 bps over German bunds, 48 bps over Spanish bonds and 33 bps over Italians.
And that was before the ECB even bought a penny of government bonds. Actual purchases aren’t supposed to start until March.
On Friday, that yield differential got even bigger. Yields on German, Italian and Spanish yields dropped another six bps while yields on U.S. 10-year bonds fell only four bps.
Why in the world would you buy those euro-denominated sovereigns, and take the risk of a free-falling currency to boot, and ignore U.S. government-guaranteed bonds, which are about a sure thing as anything on this planet?
We can certainly expect, and then, that differential to tighten considerably in the days ahead, meaning U.S. bonds prices will continue to rise.
At the beginning of the year, I said my best bond bet this year would be to buy long U.S. Treasuries. The ECB’s move on Thursday just made that an even safer bet.
I think the eventual effect of the ECB’s QE program will be the same as the Federal Reserve’s, namely boosting values of “risk” assets like stocks and corporate bonds, as it indeed already has. So we can probably expect the global equity rally to continue.
You know what they say: Don’t fight the ECB.
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George Yacik
INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
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