European markets
What has happened?
On the back of disappointing economic data and a further drop in inflation expectations, the ECB, at their government council meeting on 4th September, announced a further, unexpected deposit rate cut and the start of a version of quantitative easing (QE).
As rates were cut the month before and deposit rates (those given to banks) were already negative to encourage them to lend, this new cut was not expected. The deposit rate was cut to -0.2% and the refinancing rate to 0.05%. Draghi has said that is the lowest they will go. It is likely, as we have seen in the UK, that rates will stay very low for years to come.
As there is no further scope to cut rates, QE (not the quick, full-blown US-type, but close) will start in October. All eyes will be on the meeting on 2nd October, but the ECB will buy private bonds and asset-backed securities, which has left the door open to buying sovereign bonds at some point. It has been suggested that up to €1 trillion could be put into the market - a substantial injection of liquidity to get things going.
The aim is to weaken the euro to help growth, get banks lending and avoid deflation at all costs.
Draghi has been the master of managing expectations (unlike certain other central bankers we could mention), but expectations are now very high and, therefore, so are the risks.
What effect will this have?
If it works like it has in the US and UK, then it should mean European equities are supported. Europe is still one of the cheapest developed markets and earnings should be helped by a weaker euro, so we can expect markets to rise further.
Fixed income investors should also benefit. With rates staying very low for a long time, European fixed income will be attractive versus cash as the yields will be higher. High quality corporate bonds should do reasonably well. Asset-backed securities will also get a boost from the ECB buying programme.
One thing that the ECB needs to be aware of with this programme is that seven years ago regulators blamed similar loans and ideologies for triggering the financial downturn. Will this intervention achieve its objective to encourage bank lending?
Trevor Greetham, Director of Fidelity Worldwide Investments, explains that they currently prefer the US dollar to the euro and that they “favour US equities over those in Europe” in their multi-asset funds. Policy changes are also not enough to cause growth, and things have been looking brighter in the US, where business confidence is strong and consumers have started spending again.
What do we at Chelsea think?
Earnings are still extremely depressed in Europe and we do need to see them improve in order for the market to start to pick up. However, if we were to see some improvement in economies and earnings, domestic European stocks could do very well. The ECB measures should help, but how quickly they will filter through to the European economy, remains to be seen.
Darius McDermott, Managing Director at Chelsea explains that “whilst Europe is still cheaper than the US, the market has become more expensive and the easy money has already been made. It is, however, still the cheapest developed market, and there are still selective opportunities – it is home to some world-class companies. Draghi has put his money where his mouth is and shown he will take the necessary steps to get Europe back on its feet. Many investors will take comfort from that”.