Guess Who Else Loves Bernanke? Draghi
TheFinancialist: Emerging-market policy makers breathed a sigh of relief after the Federal Reserve left its asset-purchase program in full throttle this week. That much is obvious. What isn’t? That a certain central banker in Frankfurt also likely exhaled ever so slightly — Mario Draghi.
The head of the European Central Bank (ECB) is surely relieved that Fed chief Ben Bernanke has plans to keep his foot on the monetary gas pedal for a while longer. Not only has Bernanke given the nascent recovery in the euro zone more time to strengthen on its own, but he’s also delayed—or even eliminated—a need for Draghi to follow up bold statements with actual action.
Even a slight tightening of U.S. policy will have global implications. Just as a U.S. economic sneeze is often said to cause a worldwide cold, a Fed taper could force the ECB into additional exceptional policy moves to keep the credit tap open to companies and individuals in Europe’s struggling periphery. Higher U.S. rates would likely also push up yields in the euro zone, squeezing borrowers still reeling from the continent’s debt woes. And it’s not theoretical in nature: widespread expectations that the U.S. central bank would begin winding down its $85 billion-a-month bond buying program launched in December have already resulted in a spike in yields across much of the global bond market in the run-up to the Fed announcement Wednesday. Turkish 10-year bond yields, for example, topped 10 percent in mid-September, an increase of more than 130 basis points since the beginning of July alone. Had the Fed surprised in the other direction, things only would have gotten worse.
“The ECB’s probably not too unhappy,” said Christel Aranda-Hassel, Director, Euro Area and UK Economics at Credit Suisse in London. If the Fed had trimmed $20 billion from its monthly bond purchases — as Credit Suisse and many other market watchers had anticipated — the jolt to credit markets around the world, including the euro zone, would probably have necessitated defensive action from those economies not quite as far along in their recoveries. Which means the entire European Union. “Depending on severity of the shock, obviously, the ECB would have had to counter at some stage,” she told The Financialist.
Beleaguered euro-zone economies could obviously do without another setback, following the one-two punch of the Great Recession starting in 2008 and Europe’s own sovereign debt crisis a couple of years later. The region is just starting to emerge from a double-dip recession, with growth of 0.3 percent in the second quarter halting an 18-month slide.
“The second recession was European-made, and the recovery out of it is European-made, as well,” Aranda-Hassel said. The headwinds holding back the euro zone are starting to recede, with debt-ridden peripheral economies such as Spain and Italy working through much of the fiscal belt-tightening and structural reforms mandated by aid packages from the EU and the International Monetary Fund. While Credit Suisse expects Italy to miss its government budget deficit target of 2.9 percent of GDP this year, with a forecast of 3.2 percent, it anticipates an improvement to 2.7 percent of GDP in 2014. Spain appears on track to meet its official state deficit target of 3.8 percent of GDP in 2013, the bank says.
The ECB has played a critical role in avoiding a splintering of the currency union, thanks to its Long-Term Refinancing Operations (LTROs) to provide liquidity to banks and other measures aimed at keeping interest rates low. Draghi’s pro-active communication, particularly his commitment last year “to do whatever it takes to preserve the euro,” has also done much to reassure worried investors. Rising borrowing costs would only complicate his rhetorical task.
The euro-zone economy has lagged the U.S. recovery, which has shown enough signs of nascent strength that the Fed has signaled in recent months that the time is approaching to start unwinding some of its own extraordinary measures, starting with the asset purchases. In part to preempt any fallout in European credit markets from a tightening of U.S. policy, the ECB has broadcast its commitment to maintain or even cut rates. In July, Draghi began providing guidance that the bank’s benchmark refinancing rate would be capped at its current all-time low of 0.50 percent until further notice.
“They’ve been at pains to convince the market that rates in Europe are still going to remain low for a very extended period,” said Aranda-Hassel. If markets ignored the verbal pledges and started pushing up rates in the periphery — especially short-term yields that impact rates businesses and individuals’ pay — the ECB would have to back up their talk with action. One possible move would be changing from a variable to a fixed rate on LTROs to lock it in with the central bank’s benchmark.
Yet the ECB’s stated commitment appears to be having the desired effect so far, with yields in the euro zone largely resisting the upward pressures seen elsewhere across the globe amid expectations that the Fed was about to tighten. “The only yields that have really followed U.S. Treasuries were bunds. But those don’t matter, because the German economy is in a way better situation than the periphery in Europe,” said Aranda-Hassel.
Two-Year Government Bond Yields
Equally important for peripheral economies — such as Spain, Portugal, Italy, Ireland and Greece, which have all suffered from a big drop in domestic demand — is that the rates corporate borrowers pay have remained relatively stable after last year’s turbulence. “The amazing news was that the periphery countries had hardly noticed any of the Fed tapering talk,” she said. But Draghi surely did, just as he surely appreciated Bernanke’s sudden change of heart.
Euro Area Corporate Bond Yields
European rates did ease further after the Fed’s surprising announcement, including in the periphery. Yields on German bunds were at the lowest level in a month (as of late Thursday), with smaller declines in Spanish and Italian yields. The Fed’s decision probably buys the ECB six months or more before it has to start worrying about tightening of its own, says Aranda-Hassel. “It basically gives them some room to maneuver now, in terms of the ECB not having to care as much about what the Fed is doing,” she said. Though not intentional, Bernanke may have given his European counterpart a departing gift.
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