Cory's Insights – Thu 3 Dec, 2015
Here’s why investors booed European Central Bank’s stimulus plans
If you care to know why investors were disappointing with the announcement from the ECB this article sums it up nicely. Essentially Draghi and the ECB disappointed on all fronts of the announcement.
Now here’s the article….
“Always leave them wanting more” may be good advice for show business professionals, but that approach ensured a round of boos for Mario Draghi after the European Central Bank chief offered up a round of additional stimulus measures that fell short of investor expectations for more aggressive action.
The euro EURUSD, +2.8449% soared to a four-week high, punishing bears who had loaded up on bets a more aggressive ECB and a presumably soon-to-tighten Federal Reserve would help pound the shared currency toward parity with the dollar. European government bonds also jumped and stocks weakened. See the recap of our live blog of Draghi’s news conference.
Adding to the turmoil, the Financial Times published a pre-written story in error minutes before the ECB’s rate announcement. The story incorrectly said the ECB had made no change to its deposit rate, which triggered an initial round of euro short covering.
The ECB did expand its bond buying program, but not to the extent that many investors had been looking for. While the central bank extended its 60 billion euro a month bond buying program through March 2017 form its initially planned end date of September 2016, it didn’t increase the size of those monthly purchases.
The decision to expand the scope of items it can purchase to include regional government bonds was a disappointment to sovereign bond traders absent an increase in the overall size of purchases. And earlier, the ECB lowered its already negative deposit rate to minus 0.3% from minus 0.2%—a move that was also at the low end of expectations, while leaving the bank’s main lending rate unchanged at 0.05%. The ECB also said it would reinvest principal payments from securities it bought and extended its program of fixed-rate refinancing loans through the end of next year.
Economists were quick to pin the blame on Draghi. After all, in October the ECB chief, whose ability to jawbone the markets is deservedly renown, inspired a rally in bonds and stocks and helped sink the euro when he dropped strong hints that some very aggressive actions were in the pipeline. Subsequent comments by Draghi and other ECB officials only stoked those expectations.
This reaction from Jonathan Loynes, chief European economist at Capital Economics, captured the mood: “In short, the ECB has comprehensively failed to live up to its own hype and markets and forecasters will take future communications from Mr. Draghi and colleagues with a corresponding bucket of salt.”
So what happened?
It’s possible that Draghi—and investors—underestimated the roadblocks thrown in the ECB’s way by the Governing Council’s hawks, said Carsten Brzeski, economist at ING Bank in Brussels, in a note.
Draghi, of course, signaled no such resistance. While the Governing Council didn’t unanimously back Thursday’s actions, the moves were supported by a “large majority,” Draghi said.
He defended the ECB’s actions, arguing that the stimulus measures had already worked to disconnect consumers’ inflation expectations from falling oil prices. Without those measures, inflation next year would be a half percentage point lower than otherwise, he argued. Taking into consideration what’s already working, the ECB took what actions it deemed remained necessary and left the door open to doing even more if needed, he argued.
Draghi has a point on the economy, analysts said. Purchasing managers index readings have been gathering strength, with manufacturing activity rising to a 19-month high in November and services hitting a 4 1/2 year high, noted Matthew Weller, senior market strategist at Forex.com.
“Draghi decided that discretion was the better part of valor and opted to keep his powder dry in case it’s more desperately needed in the future,” Weller said, in a note.
For now, it’s clear investor faith in the ECB has been shaken. In fact, the market’s sharp reaction Thursday could make the ECB’s own staff projections, which had trimmed the outlook for annual inflation in 2016 to 1% from 1.1%, already look obsolete, wrote Lena Komileva of G-plus Economics.
This could create expectations the ECB will have to correct its error and announce an even stronger easing package, possibly as early as January, she said. This is part of a recipe for increased market volatility as the Federal Reserve prepares markets for a possible December rate increase and China moves toward more easing. See live blog of Janet Yellen testimony before Congress.
“The cross currents of global central banks’ communication, with the ECB’s own path now a source of risk for investors, and focus shifting to the Fed and Asian central banks, is a breeding ground for more financial volatility into the year-end,” Komileva said.