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ECB is revving the engine but the handbrake is on

By Jon Hay
20 Feb 2020

Europe’s capital markets are back in super-demand mode.

Bullish is the wrong word: the nasty risks out there are too obvious for anyone to feel happy. But the glut of cash and paucity of returns are at 2007 levels.

It’s remarkable how much bang the European Central Bank has got for its buck. Quantitative easing is just €20bn a month. Yet since August, when markets began to count on its return, the Euro Stoxx 50 has risen a sixth, while investment grade credit spreads have narrowed a quarter.

The accelerator pedal of euro capital markets is super-responsive — the slightest touch of the ECB’s foot and the engine roars.

It makes an interesting contrast with the popular anxiety that central banks have run out of ammunition to stimulate the economy. Even Stefan Ingves, the Riksbank governor who has disenchantedly ended Sweden’s long experiment with negative rates, still believes in QE.

The snag is that while the QE dog whistle works a treat in fixed income, the real economy — and its surreal alter ego, equity markets — will decouple from bond bullishness as soon as investors lose faith in growth. At that point, Europe will be in uncharted territory again. We have no idea if the QE drugs will still work when the patient already has so much in its system.

Governments must do more, economists cry. Good luck.

Rather than being cheered by the ECB’s magic, investors should consider the dire parsimony of the rich governments now negotiating the EU’s next seven year budget. Far from seeing the need to bolster EU cohesion after Brexit, the likes of Germany, the Netherlands, Denmark and Sweden are fighting over every penny.

Don’t expect them to open their wallets until the next downturn reaches another euro-threatening crisis.

By Jon Hay
20 Feb 2020