Life after Quantitative Easing

For the past 2-3 years, Quantitative Easing was one of the key monetary policy tools used by the European Central Bank aimed at, per primis, stabilising the single currency region’s economy, and secondly, stimulating growth and increasing inflationary pressures. The European Central Bank had reduced its key interest rate on a number of occasions, but that accommodative move did little to have its desired effects on the economy.

It was only after Quantitative Easing programme was announced that economic data began to show weak yet encouraging signs of improvement to the Eurozone economy. It is worth mentioning however that such improvements were not witnessed overnight. It has taken months and billions of euros being pumped back into the Eurozone economy (in the form of monthly bond purchases) for there to be any form of evident glimmer of hope that the single currency economy is out of the doldrums, is back on its feet and on a stable path to a sustainable economic recovery.

But now that we know what the benefits have been and where the economy is, the task at hand is to decipher when QE will be reduced next, by how much the next reduction in monthly asset purchases will be, when QE will be completely terminated, and the effects of each of these moves, not only on the overall economy but also on asset prices.

QE has already been on the decline since November 2016 and economists forecast this pace of reduction in monthly asset purchases to persist in a steep manner till the end of 2018. In fact, in Q4, the market is assigning a large probability that the ECB will announce tapering of its QE buying and possibly terminate the programme by latest Q318.

With the Fed imminently to commence its balance sheet reduction programme, and the Bank of Japan also expected to slow its QE buying, any announcement by the ECB to continue unwinding its ultra-accommodative stance is expected to have a global effect on yields, in the sense that with all leading central banks on the same side of the trade, any effect on yields will be further amplified as its local effects are expected to have magnified repercussions in a global context. And given the fact that markets are forward-looking, they should reprice ahead of marked expected changes in the size of QE of any leading central bank.

Naturally, what is meant to happen in theory and what eventually happens in practice may not be one and the same, due to a number of reasons; primarily market forces and prevailing market conditions, but what is certain is that the trend and direction in yields is evident. It is the magnitude of the impact which is not yet known, but when the ECB decides to eventually put the lid on QE, investors must make sure that they would have taken the necessary precautions to limit the damage on their bond portfolios as interest rates are set to rise in an indiscriminate manner.

 

This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.  

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