ECB's Draghi - '˜Super Mario' once more

11 March 2016

We did not envy the European Central Bank's president Mario Draghi with his task of last week. Not only did he have to get his disparate national committee members to agree a meaningful extension of monetary stimulus measures for the Eurozone economies to prevent deflationary tendencies obstructing further economic progress. He then had to also persuade somewhat fearful capital markets which have been on edge since Christmas over fears that central banks have run out of anti-recessionary ammunition that he is still able to pull a '˜bazooka rabbit' out of his hat. The latter was particularly fraught with risk after his failure to deliver the right message last December.

It almost felt as if tantrum-prone markets could now bully the ECB into actions like lowering interest rates into excessively negative and banking sector damaging territory or having to buy ever more government bonds at ludicrously overpriced levels in order to deliver more QE.

In the end Mr Draghi demonstrated that central banks still have a few more quite effective measures to deploy and by no means have become so predictable that they are at the whim of markets. Yes he increased the volume and the length of the existing QE programme by more than expected, but more importantly he will deliver it in a way which will not bestow windfall profits on short term speculators in government bonds, but appears to have devised quite an effective way of persuading Eurozone banks to continue in their recent credit growth to businesses and consumers.

He furthermore avoided being drawn into a race-to-the-bottom type currency war through ever lower interest rates, which would have also undermined the very sector he is trying to nurture back to full functionality - the banks. Markets initially disliked his '˜disobedience' to their interest rate expectations, but then the next day came to realise that his measures are most probably better suited to achieve medium term economic growth, even if that means that they may have to work a bit harder to find the real, rather than the easy return opportunities. We have dedicated a full article to the subject as well, because it is for the time being most probably a far more important influencer of economic growth and capital returns than the current US Primary mudslinging or UK Brexit patriotism versus pragmatism debates.

The '˜not-so-bad' trend of the past 2 weeks continued strongly in the industrialised world of the old G7, with industrial production reports and manufacturing orders for the past 2 months being reported as far better than negative market action had many led to believe. Oil and commodity prices also strengthened further, either indicating that Saudi Arabia has been cutting production as a form of '˜war dividend' to Russia for its decisive military engagement against Daesh/ISIS or that commodities have indeed found a bottom. Beaten up developing world stock markets have also staged a formidable turnaround, which some already see as the turning-point after years of disappointing returns.

All in all a turn for the better that seemed inconceivable just a few weeks ago, but we always said was our central case for 2016. We are slowly beginning to see the stabilisation and growth evidence points come through and if this positive flow continues for another couple of weeks, then the time may well come where once again the low return perspective of bonds for the medium term becomes a short term sell-off risk for this asset class. Watch this space.