Mario Draghi may be the euro region’s great protector, but investors can still get hurt.
From Portuguese government bonds to Italian bank stocks, the most stressed parts of the euro region are providing a reminder that the European Central Bank president’s stimulus and safety-net programs don’t bring immunity from losses. It’s an alarm that could prove timely if a series of political risks from Spain to Greece materialize.
With the ECB’s crisis-busting Outright Monetary Transactions program unveiled in 2012 and the quantitative- easing plan since last March, markets were mostly anesthetized to politics until now. While they look nothing like they did during the meltdown five years ago, investors wondering when the drugs would start to wear off may have their answer.
“The minute there’s a real motivation to sell, it doesn’t matter that someone is buying bonds through QE,” said Charles Diebel, the London-based head of rates at Aviva Investors, which oversees about $351 billion. “As long as nothing really changes you could say that QE provides some support, but in and of itself it doesn’t really.”
In reality, the countries that characterized Europe’s sovereign debt crisis from 2010 to 2012 never went away as potential sources of turmoil for financial markets.
There was the arrival of a government in Portugal antagonistic to the reforms of its predecessor, the potential for a similar one in Spain and the looming threat that Greece’s rescue program will unravel.
The simmering refugee crisis also has the potential to crack the consensus underpinning the European Union, while banks such as Credit Suisse Group AG are warning that markets are underestimating the impact of Britain’s vote on whether to stay in the bloc. All this, when the global economic hinterland even has Apple Inc. worried.
“After the combination of OMT and QE, markets had priced out the potential for nasty events,” said Marco Valli, chief euro-area economist at UniCredit SpA in Milan. “But QE is not aimed at neutralizing political risks.”
The yield on 10-year Portuguese bonds has climbed since Prime Minister Antonio Costa formed a government in November pledging to ease austerity. The premium over benchmark German bunds last week was the widest since the QE program began.
In Italy and Spain, it’s banks that suffered as investors dumped assets linked to the countries’ financial weak spots.
Italian banking stocks lost 20 percent this month because of concern over plans to reduce non-performing loans. The government in Rome and the European Commission agreed on a plan late Tuesday to help banks offload bad debt, though Banco Popolare di Milano Scarl extended its January decline to more than 30 percent on concern the deal was watered down and doesn’t go far enough.
Spain’s Banco Santander SA and Banco Popular Espanol SA slumped to levels not seen since the height of the financial crisis as anti-austerity party Podemos jostles for a role in the next government following an inconclusive election in December.
Greek government bonds are falling again as Prime Minister Alexis Tsipras heads for another clash with his European creditors over pension reform linked to bailout payments.
“If you were as a result of political risk fairly uncertain about, say, Spanish debt, would it make a difference that the ECB was buying it?” said Diebel at Aviva. “You’d still sell it.”
That said, the ECB’s current QE purchasing pace of 60 billion euros ($65 billion) of debt a month has only been in place for 10 months, meaning its effectiveness is barely tested.
OMT, which could be more targeted to the euro area’s fragilities, has never been deployed. It comes with strings attached and also continues to face legal challenges, with Germany’s constitutional court scheduled to hear arguments against it on Feb. 16.
Ready and Willing
Policy makers in Frankfurt make it clear they’re committed to the stated goal of the QE program, returning annual inflation rates back to just under 2 percent. If political or other events were to provide such a jolt to the markets that financing conditions for the economy worsened and the growth outlook dimmed, the ECB would surely step up its purchases, according to UniCredit’s Valli.
Draghi last week signaled a boost to QE as soon as March on the back of this year’s further declines in oil prices and uncertain global outlook. Rather than bow to criticism of the ECB’s three-year failure to meet its inflation outlook by changing the target, Draghi appears set to ratchet up stimulus as long as needed.
“We’ve plenty of instruments,” the ECB president said last week at the World Economic Forum in Switzerland. “We have the determination, and the willingness and the capacity of the Governing Council to act and deploy these instruments.”
Even so, the clouds are moving again over the euro area.
The arrival of more than a million refugees in the past year has used up German political capital in particular, with the leadership of Chancellor Angela Merkel now questioned. European Commission President Jean-Claude Juncker, fearing a collapse of consensus and the shutting of inter-European borders, has said the refugee crisis could endanger the existence of the euro itself.
Suddenly, the election of an anti-austerity government in Spain or the rise of the far-right in France look like feasible trip-switches for nervous investors to dump government debt or related assets — up to the point where the ECB has to get involved, according to Nick Kounis, head of macro research at ABN Amro NV in Amsterdam.
“Peripheral risk will linger,” he said. “It’s very unpredictable and there are potential triggers all over the place.”