(The opinions expressed here are those of the author, a columnist for Reuters.)
By James Saft
Sept 4 (Reuters) - For all the uncertainty around the European Central Bank’s extraordinary monetary policy, one thing is for sure: it’ll be good for carry trades.
If an asset has a higher yield than euro-denominated ones, and in today’s world many, many do, it will benefit from increased flows from investors borrowing in euros and making bets elsewhere. Notable beneficiaries will be emerging markets, but the fun hardly stops there.
The ECB on Thursday made a slate of moves to react to weakening growth in the euro zone. Three policy rates were cut by 10 basis points, leaving the deposit facility at negative 20 basis points, in a move the ECB signaled was the end of the road for conventional easing.
Also unveiled was an asset-backed security purchase program, to be launched and detailed in October and to be accompanied by a similar plan to buy covered bonds. All of this apparently moves us closer to outright quantitative easing, with sovereign bonds being bought on the secondary market.
This all was probably justified, and might even work. Or help, at any rate, though the list of provisos and limitations to monetary policy effectiveness in the euro zone is long.
What cannot be disputed is that money funded in euros will get cheaper, though infinitesimally, and some cash now parked by banks may move off of the sidelines, put to work in those projects or speculations bank clients care to make.
A few basis points here or there may not make a huge difference to the decision of a German middle-market company to invest in new machinery, but certainly will disproportionately benefit leverage-intensive activities, like say, borrowing short in euro and going long emerging markets.
“To the extent that at least some part of that money will head abroad, the turbo-charged easy money will likely invigorate euro-funded carry trades,” Citigroup foreign exchange strategist Valentin Marinov wrote in a note to clients.
“As a result, foreign investors buying euro-denominated assets would be hedging their downside risk more aggressively. Last but not least, stronger domestic demand in the Eurozone on the back of the ECB measures could lead to deteriorating external imbalances and weaken the euro.”
The euro will weaken, as indeed it already has, and financial markets globally will get a bit of a fillip, at least until the outcome of the Fed’s rate hike discussion is known later this year.
Indeed, the ECB’s move was big enough and unexpected enough that it very possibly will make Friday’s U.S. jobs report just that little bit irrelevant. We are highly unlikely to get a result on Friday that is as surprising as the ECB’s slate of moves, meaning that we should definitely end the week in a more bullish mood toward risk than we started.
“Today was a huge day for global markets. The ECB sent a much more powerful message than had been anticipated, killing the policy disappointment risk in the process,” emerging market strategist Benoit Anne of Societe Generale wrote to clients.
“You can now all relax and enjoy another strong leg of this emerging markets rally. Yes, this rally will end at some point -although not anytime soon - but the ECB has just given it a new breath of life.”
So, good news for risk-taking and for financial assets, but what of the longer term?
Financial markets are in receipt of a major surprise boost to risk-taking, something which happens arguably all too frequently.
Indeed, in the years since the acute phase of the financial crisis, we’ve had one extraordinary boost to risk after another: QE1, QE2, QE3 in the U.S.; various alphabet soup initiatives by the ECB; Abenomics in Japan.
Each time risk-taking is boosted, but evidence that the underlying economy benefits in proportion is far from clear.
It isn’t so much that it is wrong to put in place a policy, as the ECB, Fed and Japan have, that has speculative flows as a side effect. Rather the concern is that the immediate beneficiaries of those speculative flows get their share with a high degree of certainty, while the rest of us wait around to see if the economy will recover.
In the euro zone, with its awkward arrangements and dependence on unlikely reforms, that is far from a sure thing.
Enjoy your carry trades while you can. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft) (Editing by Dan Grebler)