The European Central Bank met last week to discuss and set monetary policy in the Eurozone. With growth declining and inflation waning across the currency bloc, market participants were looking for the ECB to announce an increase to their asset purchase program, specifically a plan to purchase European sovereign bonds. In a press conference following the announcement, ECB president Mario Draghi provided many assurances that the central bank stands ready to act, but offered neither concrete details nor a timeline for any quantitative easing program. The market punished the Euro on the news, sending it to a two-year low of $1.24 versus the dollar. Recent economic numbers out of Germany, the economic bellwether of the Eurozone, point to a possible recession. Other European countries, such as France and Italy, are struggling as well.
We wrote last week about the Bank of Japan’s plan to massively increase the size of its balance sheet through asset purchases. In recent years the Federal Reserve has engaged in large-scale asset purchases as well, inflating its balance sheet to record levels. The ECB has not been as aggressive and has seen its balance sheet shrink as a percentage of GDP, as illustrated by the chart below.
This inaction is a likely contributor to the lack of financial growth across the region and to the low interest rates of many European sovereigns. U.S. bond investors are impacted because the situation creates strong demand for U.S. assets, particularly Treasury bonds, as investors attempt to play a rising dollar and/or wide yield differentials. We’d be surprised if the ECB doesn’t take more aggressive monetary measures in the months ahead, but until they stop “watching” and start “doing” markets are unlikely to break out of their current range-bound levels.
Source: Wall Street Journal