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Whatever it takes or whatever I can get? The arrival of QE in Europe

After what seems like an eternity of speculation on will he/ won’t he, the arrival date for Mario Draghi’s Quantitative Easing programme (a mere 7 years after the USA one and with bond rates starting at least 200 bps closer to the zero bound) is here. On the 22nd the European Central Bank (ECB) will announce what QE it will do, if any, barring any last minute legal issues.

Some thoughts on QE and the ECB

1)      It is still hard to be sure that QE is responsible for the US economic recovery, or was it just a cyclical recovery made easier by the fact that by global standards, the US economy has a lot of flexibility and dynamism?

So whilst this chart is often rolled out:

Source: Minack Advisers

Source: Minack Advisers

We would counter this - that by mid-2011, S&P 500 margins had returned to their prior peak

Source: Minack Advisers

Source: Minack Advisers

 If it was the case that QE made a difference in the US, can we expect such a good response in Europe? Our reasons for scepticism include:

  • Whether it was a cause or coincidence, it was only after three rounds of increasingly aggressive QE in the US that the current strong economic growth started (see first comment).
  • Deflationary pressures in the US were nowhere near as entrenched when it started any of its QE rounds as they are now in Europe (unlike Japan).
  • Europe has a history of too little, too late when it comes to ECB action, and the smoke coming out of the chimney in the ECB’s new E1.4bn Palace in Frankfurt  says we might be about to get the same again. This includes rumours about:

 

  • the amount being too low;

  • bond purchases being confined to AAA paper, i.e. excluding the weaker members who need it most;

  • bond purchases being conducted pro-rata with members’ share of the ECB capital, which means Germany will get most, and weak places like Greece and Portugal least;

  • requiring QE to be done by individual member central banks.

All of which raise questions whether the process would work

  • ECB remains very politically weak, and prone to court challenge. As mentioned above, on Wednesday this week the European Court will give “non-binding” advice on the ECBs “Open Market Transactions” powers, which may make things more troubled.
  • Expectations seem high that there will be something decisive coming out of Frankfurt when it meets on the 22nd – based on the weakness of the Euro recently – which only heightens the scope for disappointment.

3)      If Japan is any precedent for Europe, then the only sure thing we can expect even from ‘large’ QE in Europe is a weak Euro, as Japan’s huge amount of money printing has only just moved the dial on deflation, the economy remains stagnant, but the yen has fallen massively.

Source: Minack Advisers

Source: Minack Advisers

Source: Minack Advisers

Source: Minack Advisers

Our conclusion? Remain cautious on Europe, and underweight Continental European equities as this could be tails? “You lose”, heads? “You lose” environment. If the ECB does come through with something reasonable, much of it may already be in the market, and a lot of the gains on shares may be eaten up by currency losses. If the ECB doesn’t do what is expected/hoped for, there is going to be another round of concern about the sustainability of the Euro.

There is also the small matter of Santander Bank having to do an overnight E7.5bn equity issue on Friday, a company that only recently passed the ECB stress test…but who ever asked a question they didn’t know the answer to?

Santander is denying it has raised the money for M&A. If that is true (and there are rumours it wants to buy Italy’s stricken Monte Dei Paschi di Siena) it suggests it has worked out that it still doesn’t have enough capital. If that is true of Santander, then the rest of the European banking system is in a very bad way still.

For more on this, you may want to have a look at: http://www.ft.com/cms/s/0/c27ebe62-99a5-11e4-93c1-00144feabdc0.html#axzz3OZmgsWsl