2013: Intervention by the ECB, Fed has major impact – Carmignac
During the third quarter of 2012, the ECB appears to have taken the firm decision to deal with European systemic risk, according to Carmignac Gestion.
The impact of Mario Draghi’s bold stance is considerable. In stating its intention to buy unlimited amounts of distressed countries’ sovereign debt, provided that credible plans to clean up public finances and improve competitiveness are adopted, the ECB is ready to act as lender of last resort.
Economic decline in countries working to reduce fiscal deficits and adopting structural reforms can now be covered by the markets, which are feeling reassured by the presence of this potentially unlimited support. The measures announced by the ECB coincided with the introduction of further quantitative easing (QE3) of unprecedented aggressiveness in the US.
Debt markets have received no indication of the overall amount or duration of this support. It was simply stated that $40 billion of mortgage-backed securities, i.e. roughly more than half of net monthly issuance on all of the MBS and government bond market, would be purchased each month and that the situation would be reassessed in line with changes in the labour market. Thus, the decisive moves initiated by the ECB in early August and by the Fed in early September were part of global monetary easing.
Thanks to the bailout mechanism announced by the ECB and provided that they really undertake in-depth reforms, distressed European countries are regaining some leeway in the management of their public finances.
Recessionary forces in Europe could therefore recede, especially as the IMF is calling for more measured reform plans.
The firm position adopted by Draghi to prevent the risk of a break-up of the euro is of major significance inasmuch as it means that a substantial reduction in risk premiums, which stifle financial and industrial investment, can be envisaged. Despite this, eurozone economic fundamentals are still heading in the wrong direction.
US fiscal cliff
Unlike its predecessors, QE3 comes at a time when US economic growth appears to have steadied at nearly 2% and leading indicators, which had fallen in the second quarter, are starting to pick up. The guarantee that an accommodative policy will continue boosts domestic demand by creating a wealth effect for households, who are benefiting from a rise in the value of their property and financial assets at a time when their real income is barely moving (+1.75%).
Another advantage over previous rounds of quantitative easing is that it should not push up commodity prices; slower growth in emerging countries will hold them back.
QE3’s main reason for being is to reduce the risk of a fiscal cliff by assuring households and business that if Congress and President Obama fail to reach an agreement, all the necessary cash will be provided if tax hikes and spending cuts have to be made on 1 January. This reassurance is important given the recessionary effects that could be triggered if the budget deficit is automatically reduced by around 3% of GNP.