When it comes to injecting money into an
ailing economy, the European Central Bank may want to study the
Federal Reserve’s playbook to prepare for an initial increase in
bond yields that would hinder rather than help any recovery.
After starting with what it termed “credit easing” in
2008, the Fed embarked on three stages of so-called quantitative
easing, which involved monthly purchases of bonds. Treasury (USGG10YR)
yields dropped before the Fed’s stimulus announcements, only to
rise as the policy was implemented. ECB officials led by President Mario Draghi are studying a bond-buying program that may be announced as early as their Jan. 22 meeting. While faster growth should eventually boost bond yields as the economy improves, the risk is that the cost of borrowing rises too soon.
“The whole implementation has to be done in a way that keeps the fantasy for more alive, just in case it’s needed,” said David Schnautz, a fixed-income strategist at Commerzbank AG, Germany’s top-ranked primary dealer by bond-sales volume. “The Fed didn’t manage to get away with just one round. They needed to follow up a couple of times.”
ECB policy makers want to boost the central bank’s balance sheet by 1 trillion euros ($1.2 trillion) in measures that typically depress borrowing costs.
Yield Records
Speculation that the ECB will start a program of purchasing sovereign bonds as early as its next policy meeting to help achieve that has pushed yields from Austria to Portugal to record lows, with Germany’s benchmark 10-year yield reaching 0.432 percent on Jan. 7.The yield on Germany’s 10-year bunds could drop to as low as 0.35 percent as the ECB implements the program and then increase once it gets going, Schnautz said.
The average yield on euro-area government debt dropped to 0.7847 percent on Jan. 2, the least for more than two decades, and was at 0.7907 percent on Jan. 12, according to Bank of America Merrill Lynch indexes. That’s down from 4.28 percent in November 2011, when political upheaval in Greece fueled concern that the euro area might disintegrate.
“We are expecting 500 billion euros plus the warning that they could do more should conditions worsen,” said Ciaran O’Hagan, head of European rates strategy at Societe Generale SA in Paris. “That will be enough flow to ensure that bonds will be well supported over the coming months.”
Fed’s QE
When the Fed announced in March 2009 that it would add Treasury purchases to its debt-buying program, the 10-year yield slid from about 3 percent to as low as 2.46 percent, before rising to 4 percent before the end of the year.Its third and final leg started in January 2013 with 10-year rates at about 1.75 percent. They peaked at 3.05 percent in January 2014 before falling to 1.86 percent late yesterday.
With the 57 percent slump in oil prices over the past six months slowing inflation across the world, bond trading signals that investors are skeptical that the ECB will succeed in boosting growth and inflation.
The extra yield that investors get for holding German 30-year debt instead of securities maturing in two years dropped to 105 basis points on Jan. 2, the least since October 2008, when the euro area was in recession. Longer-dated debt usually has higher yields to compensate for the inflation risk.
“The shape of the bund curve suggests that the market is very skeptical about how effective the policy response from the ECB will be,” said Jack Kelly, an investment director at Edinburgh-based Standard Life Investments, which manages about 200 billion pounds ($303 billion). “Typically with a QE expectation, you would expect the long end to start pricing in reflation, growth and so on. That’s not happening in Europe.”
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