ECB: markets need time to absorb huge liquidity

Eurozone: Greeks go to polls

ECB – markets need time in order to absorb this huge liquidity

With its strong and more or less unlimited commitment to purchase bonds, the ECB has been able to surpass the already ambitious market expectations. In its current structure, size (EUR 60bn per month) and time frame (from March 2015 until probably September 2016) the broad-based asset purchase program has been outlined very clearly and comprehensively. We think that around EUR 45-50bn of monthly purchases will relate to government bonds and agencies, while the remainder will pertain to ABS and covered bond purchases. The purchases of government bonds from Eurozone countries as well as from agencies will be based on the Eurosystem National Central Bank’s shares in the ECB’s capital key. The issuer limit (not more that 33% from one issuer) and the issue limit (not more than 25% of one issue) result in modifications regarding the possible volumes. The decision that not all purchases, but only 20%, are subject to loss sharing is not desirable, however, and, according to M. Draghi, this has been the most important detail in the decision-making process. Thus the National Central Banks remain in charge for the majority of purchases (80%) and have to bear the potential losses of write-downs. An integral part of the purchase program is the fulfillment of one condition. The ECB intends to purchase until a “sustained adjustment in the path of inflation towards price stability is taking place”. The ECB can lay the foundation for growth, but as has been outlined already quite often, the governments have to deliver the urgently needed fiscal and economic reforms in order to increase long-term growth. In this regard, the January bank lending survey of the ECB is showing encouraging development regarding demand for loans for investments. Weak investment activity is one of the biggest challenges to the Eurozone economy. It remains to be hoped that demand for loans will further rise so that the ECB’s purchase program can – even though yields are already on a low level – have its full impact on the real economy.

The bigger than expected ECB measures are weakening the euro and could support economic recovery in combination with the low oil price. This should allow the rate of inflation – after a very low phase in 2015 of close to zero – to return to normal levels in future. In step with a foreseeable economic recovery, the yields of German government bonds should rise moderately, although this will take some time. This should be supported by diminishing safe haven flows (the ECB does whatever it takes). Nevertheless, purchases of German government bonds will dampen the yield level due to Germany’s high capital key at the ECB. Furthermore, the market will need some time in order to absorb the excess liquidity and to develop confidence in a foreseeable economic recovery. Some investors might also wait by not switching into higher risk assets – as has been anticipated by the ECB. We therefore adjust our yield forecasts for German government bonds over the entire horizon by 40bp. Due to the substantial differences between US monetary policy and euro monetary policy, we have also lowered our USD forecast.

Greece: Syriza leads opinion polls

The snap elections on Sunday in Greece point to a redirection of the Greek political landscape. Most likely, the left-wing party Syriza will come out as the winner of the elections, according to various opinion polls, with a lead of more than 3% over Nea Dimokratias. The newest survey by the opinion research institute Kapa Research predicts that Syriza will get 31.2% of the votes, but their share could be even bigger on Sunday, as around 10% of voters declared that they are still undecided. The Greek election system is in favor of creating majorities. While a scenario of the party governing alone is imaginable, more likely a coalition partner will be needed to form a government. We assume that the most likely candidate for a coalition is the 2014-founded left-liberal party To Potami, reaching third place in the polls.

Survey data 2015 vs. Election result 2012

Due to Syriza’s call for a haircut and an end to austerity, voices have again risen regarding the possibility of Greece leaving the Eurozone. We see a ‘Grexit’ as unlikely for three reasons. First, the rhetoric of Syriza has calmed down in recent weeks; a haircut is no longer the primary goal. Second, the need for a coalition partner will complicate the implementation of the calls. And third, the Greek population itself is (with a vast majority) for staying within the Eurozone. Instead of a haircut, there could be some other form of agreement, e.g. a reduction of interest rates or longer durations. The outcome of the elections will be interesting with respect to Portugal and Greece, where there will also be elections in September and December. Should Syriza succeed in the elections and the resulting negotiations, the protest parties in those countries, such as “Podemos”, would see support in their claims for similar policies.