The ECB announced QE using a predictable “shock and awe” approach, announcing a €1.1tr QE program, in line with our expectations but well above the €500-600bn markets had priced in.
Key points include:
- Total QE will hit its highest level ever in 2015, due to the combination of ECB and BoJ programs.
- Bond yields globally will be lower for longer – the Fed will be slower to raise rates for fear of USD appreciation hurting their recovering economy.
- QE is unlikely to do much for the EU. Structural economic issues remain worrying, specifically the need for deeper integration of its banking system and monetary policy and the lack of willingness to address this core issue. The Greek election result increases concerns that Greece defaults and exits the EU. That would send shockwaves across financial markets not for the sake of Greece itself, but for what it means for the viability of the EU in the long term.
- Furthermore, unlike in the US and UK where QE arguably had some positive impact, the EU is less dependent upon finance markets (which QE supports) and more dependent on exports. The problem for the EU is that two of its major export market competitors are also embarking on currency-deflating strategies: Japan’s QE is as big as Europe’s and China is lowering interest rates.
- The USD’s bull run has just started. In the past, when a similar weak global outlook was evident, the US was also the strongest economy and, the USD rose by 30-40% over a 2-3 year period.
- The Fed will not want the USD to rise too much against its major trade competitors, namely the EU and China, so they will keep rates as low as they can get away with.
- Australian inflation is at risk of a significant increase in the next few years when oil prices return to normal levels, but the AUD remains low, particularly if the global QE experiment starts to create inflation issues in the US and EU.
In summary:
- Lower for longer interest rates suggest lengthening duration before markets reprice
- Inflation linked bonds are currently pricing in Australian inflation at around 2% p.a. for the next few years. This is highly likely to be under pricing inflation by at least 50bps p.a.
- TD rates in Australia are unlikely to exceed inflation by any meaningful margin for several years
- The AUD is at risk of a continuing its significant fall against the world’s only strong currency: the USD.
FIIG is launching its “Smart Income Guide to 2015” this week. In the major themes of this document we have included, amongst other discussion, analysis of; global implications of this move by the ECB, the oil price war, the likely response by the Fed, and the implications for Australia.
For those of you wanting to read more about European QE, please click here.
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