Think about the Japanese economy over the past couple of decades. A few thoughts might spring to mind: gigantic asset bubbles, currency devaluations, inflation stagnation, extreme monetary policies and the highest public debt per capita on the planet. Japan hardly appears to be a model of prudent economic policy.
Yet that is the model to which Europe has subscribed. In the face of stubbornly weak inflation and tepid economic growth, the European Central Bank (ECB) last week launched a new policy package designed to stimulate the economy.
It opted to cut the deposit rate by 0.1% to an all-time low of -0.5% and committed to purchasing €20bn of bonds a month until such time as it raises interest rates. With the market not expecting any rate hikes until March 2023, this currently equates to an additional €820bn of bond purchases, but could well exceed this figure.
Given this gargantuan long-term commitment, the market does not expect much in the way of further rate cuts. The monetary policy outlook looks to be static for a considerable timeframe. The measures exemplify the thinking behind the Japanese system of curve control.
Focus is now likely to be shifted towards fiscal policy. Indeed, the need for eurozone member states to step up their fiscal stimulus was the one point of unanimity among ECB members. As we have seen countless times over the years, however, such calls usually fall on deaf ears. Even when governments agree to do so, it often takes a lot of time to initiate new programmes of stimulus.
As the region shifts ever closer towards the end-game of “helicopter money” we have positioned our government bond funds for semi-core countries, such as Spain and France, to outperform core countries, such as Germany. Ad infinitum buying by the ECB should result in peripheral spreads tightening further. Given that monetary policy has exhausted its usefulness the short-end of curves should underperform and we are therefore positioned for flatter curves in Europe.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice. Portfolio holdings are subject to change, for information only and are not investment recommendations.