Fed ex­pe­ri­ence sug­gests ECB runs risk of ris­ing yields

The Pak Banker - - COMPANIES/BOSS -

WASH­ING­TON: When it comes to in­ject­ing money into an ail­ing econ­omy, the Euro­pean Cen­tral Bank may want to study the Fed­eral Re­serve's play­book to pre­pare for an ini­tial in­crease in bond yields that would hin­der rather than help any re­cov­ery. After start­ing with what it termed "credit eas­ing" in 2008, the Fed em­barked on three stages of so­called quan­ti­ta­tive eas­ing, which in­volved monthly pur­chases of bonds. US Trea­sury yields dropped be­fore the Fed's stim­u­lus an­nounce­ments, only to rise as the pol­icy was im­ple­mented.

ECB of­fi­cials led by Pres­i­dent Mario Draghi are study­ing a bond-buy­ing pro­gram that may be an­nounced as early as their Jan. 22 meet­ing. While faster growth should even­tu­ally boost bond yields as the econ­omy im­proves, the risk is that the cost of bor­row­ing rises too soon.

"The whole im­ple­men­ta­tion has to be done in a way that keeps the fan­tasy for more alive, just in case it's needed," said David Sch­nautz, a fixed­in­come strate­gist at Com­merzbank AG, Ger­many's top-ranked pri­mary dealer by bond-sales vol­ume. "The Fed didn't man­age to get away with just one round. They needed to follow up a cou­ple of times." ECB pol­icy mak­ers want to boost the cen­tral bank's bal­ance sheet by 1 tril­lion euros ($1.2 tril­lion) in mea­sures that typ­i­cally de­press bor­row­ing costs. Spec­u­la­tion that the ECB will start a pro­gram of pur­chas­ing sov­er­eign bonds as early as its next pol­icy meet­ing to help achieve that has pushed yields from Aus­tria to Por­tu­gal to record lows, with Ger­many's bench­mark 10-year yield reach­ing 0.432 per­cent on Jan. 7 be­fore be­ing at 0.46 per­cent to­day.

The yield on Ger­many's 10-year bunds could drop to as low as 0.35 per­cent as the ECB im­ple­ments the pro­gram and then in­crease once it gets go­ing, Sch­nautz said. The av­er­age yield on euro-area gov­ern­ment debt dropped to 0.7784 per­cent yes­ter­day, the least for more than two decades, ac­cord­ing to Bank of Amer­ica Mer­rill Lynch in­dexes. That's down from 4.28 per­cent in Novem­ber 2011, when po­lit­i­cal up­heaval in Greece fu­eled con­cern that the euro area might dis­in­te­grate.

"We are ex­pect­ing 500 bil­lion euros plus the warn­ing that they could do more should con­di­tions worsen," said Ciaran O'Ha­gan, head of Euro­pean rates strat­egy at So­ci­ete Gen­erale SA in Paris. "That will be enough flow to en­sure that bonds will be well sup­ported over the com­ing months." When the Fed an­nounced in March 2009 that it would add Trea­sury pur­chases to its debt-buy­ing pro­gram, the 10-year yield slid from about 3 per­cent to as low as 2.46 per­cent, be­fore ris­ing to 4 per­cent be­fore the end of the year. Its third and fi­nal leg started in Jan­uary 2013 with 10-year rates at about 1.75 per­cent. They peaked at 3.05 per­cent in Jan­uary 2014 be­fore fall­ing to 1.89 per­cent to­day. With the 57 per­cent slump in oil prices over the past six months slow­ing in­fla­tion across the world, bond trad­ing sig­nals that in­vestors are skep­ti­cal that the ECB will suc­ceed in boost­ing growth and in­fla­tion.

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