The most important event on the financial markets last week was the press conference given by President Mario Draghi of the ECB. That press conference yielded less concrete information about future policies than had been anticipated, however, and the markets made their disappointment clear.
Draghi stressed the effects of falling oil prices on inflation in Europe, but made no mention of the positive impact on Europe’s economic growth
Ben Steinebach Head of Investment Strategy
Although Draghi’s analysis hinted at serious concerns about possible deflation in the eurozone, he did not announce the policy measures that the markets had expected (or hoped for). Draghi stressed the effects of falling oil prices on inflation in Europe, but made no mention of the positive impact on Europe’s economic growth: doubtlessly he hoped to reassure the financial markets that the ECB is in fact prepared to take additional measures if necessary.
By failing to say whether he is ready to introduce a large-scale programme for purchasing government bonds (QE), however, he achieved the opposite. Both the stock markets and the bond markets fell. Presumably Draghi did not wish show his hand entirely, not having yet exhausted all the other instruments at his disposal. This week banks can apply to the ECB for the second tranche of the TLTRO facility (which offers cheap money that may not be used for buying government bonds or providing mortgage loans). Participation in the first tranche in September was a disappointing EUR 86 billion (of the EUR 400 billion available in total).
Draghi will want to wait and see whether participation will be higher this time, which is not unlikely: LTROs from 2011 and 2012 are set to end shortly and banks are likely to need a fresh injection of money. In addition, the ECB is still purchasing mortgage-backed bonds, and it also has the option of buying up corporate bonds. Although it is doubtful whether this will serve to add EUR 1000 billion to the balance sheet, the ECB will nevertheless wait to see whether these instruments achieve their purpose. This should be clear by January 2015, and if necessary the ECB can then begin purchasing government bonds to launch a true quantitative easing programme.
Stock markets without any clear direction
Draghi’s press conference on Thursday was felt hardest by Europe’s stock markets, which dropped more than their US counterparts. Nevertheless the AEX succeeded in recording a new high for the year on Wednesday. The macroeconomic news affecting the exchanges last week was mixed, and little of note happened in terms of corporate news. A long list of countries reported on the sentiment among purchasing managers during the earlier part of the week.
In the United States that sentiment was extraordinarily encouraging, while the mood in Europe indicated that the outlook was unfavourable and disappointing. This further fuelled the pessimism surrounding Europe’s economy, and by Thursday most European stock markets were posting losses of around 1% relative to the Friday before. The US exchanges did better, on balance gaining slightly, though technology market NASDAQ was an exception and fell almost 0.5%. By Friday, however, the European markets had recovered, boosted mostly by favourable data about industrial orders in Germany: the 2.5% improvement in October was much better than had been anticipated, and was generated mostly domestically (+5.3%).
As the data for September were also adjusted upward, it is safe to conclude that the German economy’s weak moment was limited to August, when incidental factors played an important part. In part because of this, on the morning of 5 December the AEX reached a new high for the year (428.90). Unilever announced its decision to transfer its margarine and oil operations to a separate division. This seems to hint at a sale of those operations, which has been a source of speculation among analysts for some time.
Bond markets also disappointed in Draghi
Interest rates on the bond markets rose everywhere after Draghi’s press conference failed to provide the necessary clarity. This did not break the overall trend in Europe, however, which continues downward and is boosting the European market for corporate bonds. As the European bond markets have already allowed for the fact that the ECB cannot avoid a large-scale bond purchasing programme, the markets responded negatively to the lack of concrete measures and prices fell. Nevertheless, falling oil prices (and the resulting lower inflation outlook) and monetary easing – not only in the eurozone, but also in Japan and China – mean that Europe’s bond interest rates remain extremely low.
A further consequence was that the markets for corporate bonds also performed well, with European corporate bonds remaining particularly attractive relative to their US counterparts. The US economy is further along in the economic cycle and the demand for credit is higher, with companies needing funds for mergers and acquisitions. In addition, the central banks (the Fed and the ECB) have taken different paths. These factors combine to make European corporate bonds more attractive than US bonds, as can be seen from the increasing yield differentials.
Markets still dominated by macro news
No meaningful corporate news is expected this week. The financial markets will again have to be satisfied with considerable volumes of macroeconomic news, including numerous reports about industrial output in various countries. Following the impact of the US job market and unemployment data on the market sentiment last Friday afternoon, this week we look forward with particular anticipation to reports about Europe’s industrial output. Both the European Union as a whole and the United Kingdom, France, Italy and the Netherlands individually will be publishing these data for October.
In other interesting news China will announce its inflation in November, and France will also publish inflation data for the same month. On Thursday banks can apply to the ECB for the new tranche of the TLTRO facility. A high level of participation will serve as an indication that Europe’s business sector needs credit and that banks are willing to provide it. On Friday an initial estimate will be announced of consumer confidence in the US, based on research by the University of Michigan.