Wednesday, May 20, 2015

Eurozone: Draghi’s Latest Pledge
ECB President Mario Draghi is the Fairy Godfather of the Eurozone’s bond market. Bond yields dropped dramatically in the region after he pledged to do whatever it takes to defend the euro. He said so on July 26, 2012. He has delivered on his promise so far. He had to renew his vows with the bond crowd along the way. He proved he meant what he said by lowering the ECB’s official lending rate from 1.00% to 0.05%, and even cutting the bank’s deposit rate below zero to minus 0.2%.

Then on March 9, he implemented a massive QE program, finally overcoming lots of resistance to it coming out of Germany in particular. All of his words and deeds pushed the euro down from last year’s high of $1.39 on May 6 to this year’s low of $1.05 on March 13.

However, better-than-expected economic indicators in the Eurozone and worse-than-expected ones in the US have pushed the euro back up to $1.14, though it retreated below $1.12 yesterday after an ECB policymaker hinted that the Bank is preparing to ramp up its bond-buying program before the summer. A few observers question whether QE was even necessary. Some are wondering whether the program should be terminated sooner rather than later. Furthermore, bond yields, which fell close to zero in mid-April, have subsequently spiked up.

So last Thursday, Draghi updated his pledge in a lecture at an annual IMF series in Washington, DC:
After almost 7 years of a debilitating sequence of crises, firms and households are very hesitant to take on economic risk. For this reason quite some time is needed before we can declare success, and our monetary policy stimulus will stay in place as long as needed for its objective to be fully achieved on a truly sustained basis.
Thus, he tried to sink the suggestion that the ECB might wind up its QE scheme early.

To make sure everyone got the message, Benoît Cœuré, a member of the ECB’s executive board, said in London on Monday evening that the bank will front-load some of their purchases of sovereign debt in May and June to deal with an expected shortage of liquidity in July and August. (His remarks were not published by the ECB until Tuesday morning, raising questions about the release of market sensitive information by the central bank.) Obviously, ECB officials want to squelch any notion that they will taper the pace of bond buying.

The markets got the message, as the euro edged down and stock prices jumped higher.
(Based on an excerpt from YRI Morning Briefing)

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