Just like in the old disco song, we can imagine Mario Draghi feeling a great sense of accomplishment in keeping the European economy and the dream of the European Union alive for a while longer. Keeping the ECB’s bond buying program at 80 billion euro monthly until next March and then scaling back to 60 billion euro until the end of December 2017 will allow the ECB more time to reach its inflation goal of 2%. Perhaps more importantly, the continued easing avoids a monetary shock before some very important elections in the EU next year. Any shock to the economy could give support to the populist and nationalist candidates in Germany, France, and Italy and could hasten the disintegration of the European Union. Without the EU, what happens to the ECB? No one knows for certain, but for now Mario is just “Stayin’ Alive.”
However, while the ECB is “Stayin’ Alive,” others are not. The European Central Bank has rejected a request from Rome to delay a private sector-led rescue for Monte dei Paschi di Siena (MPS). This leaves Italy with few options but to trigger a government bailout and impose losses on creditors unless private investors come forward at the 11th hour. The Italian economy and banks have suffered greatly since joining the EU’s common currency. The Italians used to stay competitive with Germany by devaluing the Lira, but with a common currency the Italian economy has failed to be competitive, job and economic growth have been lost and the banking system has been hobbled. Now the ECB wants MPS’s creditors to take losses. This is a bitter pill, and could lead to further destabilization of the Italian banking sector. The contagion could even run to other EU banks.
We do not own any European banks in our portfolios, and would not be tempted. There is way too much political and economic risk and very little return. We remain careful concerning contagion risks. With fixed income spreads relatively tight and interest rates low, there is very little difference between strong and weak issuers and securities. It just makes sense to buy the strong–those more likely to keep “Stayin’ Alive.”
Source: The European Central Bank, The Financial Times, Bloomberg