This question has come up a lot recently, so let's discuss it. What follows will be my take on it, and I have no idea if it will be the right take. That's the nature of this topic though. There are too many moving parts and too many potentially unseen variables to conclusively say ECB QE will be good or bad for rates.
All that having been said, I'm not going to offer an equivocal, cop-out, "could go either way" kind of answer. I definitely have a stance here and some clear assumptions on ifs/thens. I'm just saying the topic is big and complex enough that my stance could easily prove to be wrong. We'll see.
What are we even talking about?
To be sure we're on the same page, this conversation is about quantitative easing (QE) on the part of the European Central Bank (ECB). While the ECB has successfully rolled out 2 separate bond buying schemes, neither have involved new money creation--a requisite ingredient of QE.
Why should we care if the ECB does QE anyway?
While it's true that the focus of our long-term discussion is mortgage rates and MBS, we care about this ECB stuff because of the proven domino effect leading right back to rates and MBS. It's not a direct relationship, but certainly, the actions of the world's biggest central banks can shape the broader trends in interest rates. With the Fed not being in much of a position to surprise markets in a meaningful way and with the Eurozone being the largest collective economy in the world, AND with parts of Europe drifting dangerously close to deflation and recession the next big move in Europe matters greatly. Thursday's ECB Announcement may be a central ingredient in that potentially big move.
Well, if QE was generally good for rates in the US, won't it be good for rates in the Eurozone?
This is where things get tricky. First of all, the circumstances leading up to the Fed's various iterations of QE were very different. By the time we got around to successive QE's, the benefit wasn't so much to economic stability as it was to MARKET stability (guaranteed tradeflows in financial markets would theoretically, eventually work their way through to consumers).
Bonds rallied because they knew they were going to get lots of money, even before the money started flowing. There were only two places for the money to go (Treasuries and MBS), so throughout the times where QE was obviously imminent or actually taking place, it made zero sense for rates to be anything other than much lower than they otherwise would be.
So QE is imminent in Europe. That means rates are low in anticipation and will stay low due to bond buying, right?!
Not so fast... First of all, the Eurozone isn't one tidy little country like the US. The ECB has a real mess on their hands in determining 'who gets what' in the event of QE. The countries that are likely to be the biggest winners are the ones with the least amount of correlation to US rates. That's the first problem.
The second problem is that we can't even be sure that QE would be implemented as announced due to the Eurozone's infinitely messier politics and policy.
Why can't we be sure QE would happen as announced in Europe?
In the financial world, the ECB is an infant to the Fed's grandpa. During much of the European crisis, it hasn't even been clear who could do what and when! It doesn't logically seem like this should be the kind of thing that's happening when it comes to trillions of dollars of spending authority, but this is very much like a corporate scenario where a decision is made to interpret a law in a certain way, act on it in a major way, and trust that your attorneys are better than those who will sue you.
Reality isn't so far off from that scenario. The ECB announced their most recent bond buying program without buy-in from Germany. They didn't really know if it was doable. On one side, ECB President Draghi and bond-buying proponents argued it was within their mandate. On the other side, German officials argued it was illegal per the Eurozone treaty. Draghi effectively said "well, we'll see" and pulled the trigger on the program.
You'd think there would be some way to determine the feasibility before the program was actually announced, but no. After it was announced Germany subsequently sued the ECB in German court, preventing the bond-buying from taking place, but not killing to program outright. That decision was (and still is) to be made by an even higher court (European Court of Justice, or ECJ).
As of last week, we have the initial assessment from the ECJ that the old non-QE bond-buying program is probably going to be just fine. For some reason, QE proponents have taken this to mean that the next bond buying program will be similarly justifiable despite the ECJ's assertion that they were only talking about the old program. It's another gamble, but a less crazy one in light of the way the ECJ established this 1-instance track record of telling Germany to go back to its corner.
Even then, it wouldn't stop Germany from raising an objection to anything in the new program that violates their reading of Eurozone laws.
So we're probably getting European QE, but we don't know how it might unfold relative to what's announced? Wouldn't that lessen the impact of the announcement?
Correct. But that's not the only reason that it could have a less substantial impact than US QE (which everyone understood constituted a guaranteed schedule of bond buying).
Europe is 'farther gone' economically than the US was prior to QE2 and QE3. (NOTE: I'm comparing this potential European QE to the Fed's 2nd and 3rd rounds because Europe's functional equivalent of QE1 already happened in 2012. In other words, we're now dealing with the battle against persistent weakness as opposed to initial crisis response).
In fact, the writing is on the wall to such an extent that Europe desperately needs SOMETHING to stem the seemingly unstoppable tide of economic instability and impending deflation. If this seems like too bold a statement, simply consider that Germany's 10yr yield ended yesterday at 0.45% and has continually broken all-time low yields in 2014 and 2015. Low yields can only mean so many things, and impending deflation and economic troubles are most of them.
Europe is so far gone that--unlike QE2 and QE3 in the US--European QE could actually be taken as an important signalling mechanism that the ECB can actually push aggressive accommodation through the European political maze.
In the US, QE2/3 provided a moderate boost to an already recovering economy. European QE, on the other hand, stands a chance to help Europe finally find a bottom in terms of the slide in inflation and economic growth (yes, this is of course the most optimistic scenario in terms of QE's efficacy, but it doesn't mean market participants aren't hoping that's the case).
What's the thesis here?
It was hidden in the last paragraph. It bears repeating: the ability of the ECB to enact QE could be the beginning of the inflationary and economic turning point the Eurozone is desperately looking for. Markets already assume it's coming, which is one of the reasons yields are where they are. Unfortunately, that doesn't leave room for the actual tradeflows to benefit European bond prices.
This means that any additional drop in Eurozone yields will have to come from more deflation and economic weakness. Thankfully, the simple act of announcing QE won't have an immediate impact on those two things--thus insulating us from any truly epic selling-sprees. Unfortunately, neither would a QE announcement be a surprise.
It's possible that factual confirmation of QE would have a temporarily positive effect on the parts of the bond market that stand to benefit from the tradeflows, but apart from that, markets have already done their best to buy this rumor. There's really nowhere to go but higher in rates unless the Eurozone keeps deflating and decelerating.
As such, the less comprehensive and awesome Thursday's potential QE announcement is, the better I think it will be for the longer-term rate outlook.
You read that right: less QE = lower rates in big, stable, liquid (relatively) bond markets like Germany and the US. Conversely, effective QE has potentially negative implications for rates, but those could only play out gradually. The initial trading reaction and long-term trend reaction will likely be two completely different things here.
102-21 : +0-00
105-02 : +0-00
106-21 : +0-00
0.5030 : +0.0030
1.7900 : -0.0010
2.3700 : -0.0090
|Pricing as of 1/21/15 7:30AMEST|