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Strategies & Market Trends : 2026 TeoTwawKi ... 2032 Darkest Interregnum -- Ignore unavailable to you. Want to Upgrade?

To: TobagoJack who wrote (107405)	9/3/2014 1:48:22 PM
From: elmatador	Read Replies (1) \| Respond to of 219580

QE best way to mend Europe financial fragmentation By Gene Frieda Bond purchases by ECB would eliminate yield differences, writes Gene Frieda Some commentators have argued that quantitative easing would be less effective in Europe than in the US, or indeed that it would be a mistake for the European Central Bank to embark on QE. Advocates argue that eurozone monetary conditions remain too tight, reflected in weak growth and significantly below-target inflation outcomes, and, in turn, that the ECB has no choice but to launch QE. Neither side has made a convincing case as to why QE would, or would not, be effective, and under what conditions it would work best. Quantitative easing takes effect through three channels: lowering bond term premiums; via portfolio balance, altering the risk/return trade-off for investors and firms; and demonstrating the commitment of policy makers to their statutory mandate of price stability. In contrast to conventional wisdom, there is little difference between the channels of conventional and unconventional policy. The impact of QE is so great because of the context: mired in a debt-deflationary disequilibrium, unconventional monetary policy has the power to stimulate aggregate demand, allowing economic space for structural reform to work. Powerful effectsThe power of accommodative monetary policy is its ability to attenuate potential asset price losses. More than simply raising bond prices, QE lowers volatility and shifts correlations as term premiums decline, with less risk of loss for both bond and equity investors. QE benefits companies immediately through lower refinancing costs. Later, as groups optimise liabilities through debt-to-equity swaps or increased dividends, equity valuations rise. Because of the more benign macro backdrop, companies are not penalised for increasing leverage. For banks, QE has more immediate impact than the ECB’s refinancing operations, boosting bank solvency through capital gains on assets. In that sense, QE follows logically as a complement to the ECB’s comprehensive balance sheet assessment as a means to restore lending to the real economy. Most importantly, bond purchases lend credibility to commitment – action rather than abrogation of the legal mandate for price stability. Inflation expectations should, accordingly, be better anchored. The case for QE in Europe is particularly powerful. While the outright monetary transactions programme ensures markets can no longer undermine monetary union, the ECB has yet to respond appropriately to the zero lower bound on interest rates as inflation drops below the bank’s 2 per cent target. Sovereign bond yields may have fallen to all-time lows in the core and the periphery alike, but for large swaths of the eurozone, real interest rates remain inappropriately high given low levels of inflation. Beyond the normal power of QE on volatility and term premia, the additional potency within the European context is in eliminating financial fragmentation. In contrast to the US, where there is only one risk-free rate, in the euro area, there are as many risk free rates as there are sovereigns. Inferior solutionAn ECB programme to buy sovereign bonds would largely eliminate nominal yield differentiation between sovereigns, similar to the early years of the ECB’s repurchase operations, when all eligible sovereign debt was assigned to the same high liquidity category. In contrast, targeted longer-term refinancing operations, while generously priced, are an inferior solution to financial fragmentation. Since banks in Europe hold their respective sovereign’s debt as the primary form of liquid collateral, differentiated haircuts make funding more expensive for periphery banks relative to core banks. Eliminating differentiated funding costs is central to the success of additional monetary policy actions given that market-based private sector financing is still in its infancy in Europe. Just as the market is right to be impatient for monetary policy to overcome the zero lower bound, so is the ECB correct in its impatience with governments for failing to act in concert. Many of those who call for QE do so because they are unwilling or unable to deliver the necessary reforms needed to optimise QE. Similarly, opposition to QE is largely on political rather than economic grounds, since the subsidy element to ECB sovereign bond purchases amounts to fiscal risk sharing. Scope for compromise is clear. With Europe facing an existential threat from excessive debt and demographics, the impact of QE without complementary policies to improve potential growth will be fleeting. It is therefore up to European leaders to create the preconditions. The euro summit planned for October 7 is an appropriate event, none too early. Gene Frieda is a global strategist for Moore Europe Capital Management; Seamus Brown, also a global strategist, is co-write